M & A Tax Issues
By: Scott Van Vooren
This blog post is a part of Lane & Waterman’s M & A Blog Series.
Tax matters regarding mergers and acquisitions should be considered at the front end of the transaction. Some of the tax structures will be briefly described below, as well as noting a few of the provisions of the Tax Cuts and Jobs Act affecting mergers and acquisitions.
In an asset sale, a Company transfers substantially all its assets to a Purchaser in return for the purchase price. The Purchaser may assume some of the liabilities of Company and at closing, is the owner of the assets. The Company receiving the purchase price, may have assets excluded from the sale and retains its liabilities that were not assumed at closing by the Purchaser.
The Company recognizes gain or loss on the sale of its assets calculated based on the basis in the assets sold and the purchase price of such assets, including liabilities assumed. The gain or loss may be a capital or ordinary, depending on the asset. The purchase price is allocated to the assets as set forth in IRC Section 1060. It is advisable for the Company and the Purchaser to agree to a purchase price allocation in the purchase agreement.
Taxable Stock Sale
When Shareholders of the Company sell their shares of stock in the Company to a Purchaser, a Shareholder’s gain or loss is the difference between the purchase price and the Shareholder’s basis in the stock. The gain or loss is typically a capital gain or loss. The Company’s basis in the assets does not change. Generally, net operating losses of the Company remain, subject to certain limitations.
Taxable Membership Interest Sale in an LLC
When Members of an LLC sell 100% of Membership Interests in the LLC to a Purchaser, the Members’ gain or loss is generally the amount realized on the disposition and the adjusted basis in the LLC Membership Interests. In that regard the amount realized may under certain circumstances include the existing Member’s share of the LLC’s liabilities. Gain or loss is determined as set forth in Internal Revenue Code Section 741. Different rules apply when the Membership Interests are sold back to the LLC. The Purchaser will be treated as purchasing the LLC assets with the basis in the assets being the purchase price.
IRC Section 338
An election under IRC Section 338 would treat a purchase of the Shareholders’ stock in a Company by the Purchaser as a sale of assets of the target Company.
Tax-free reorganization includes:
a) Statutory merger or a reorganization (i.e. a forward triangular merger and a reverse triangular merger)
b) Stock acquisition for voting stock; and
c) Asset acquisition for voting stock.
IRC Section 368 must be met for the transaction to be a reorganization. Other requirements include business purpose, continuity of business enterprises and continuity of interest.
State Tax Implications
Careful consideration should be given to state income, sales and use, licensing fees, transfer and registration, tax implications on the transactions. These implications can vary from state to state. Also, state successor liability for the target Company’s unpaid unemployment and sales and use taxes should be considered when purchasing substantially all the assets of a target Company.
US Tax Reform
Some of the provisions of the Tax Cuts and Jobs Act law affecting mergers and acquisitions are generally noted below:
a) Tax rates have been reduced which could affect deal structure, choice of entity and projections.
b) There are limitations on the use of net operating losses arising in 2018 and subsequent years.
c) There is bonus depreciation for 100% of the adjusted basis of quantifying property in service after September 27, 2017 through December 31, 2022. The percentage will be reduced annually for purchases from January 1, 2023 through December 31, 2026.
d) Generally, for tax years beginning on or after January 1, 2018 and before January 1, 2022 most businesses are limited to interest expense deductions up to 30% of adjusted taxable income.
Tax implications should be considered before settling on the structure of your transaction.
Scott is a senior partner in Lane & Waterman’s Mergers & Acquisitions practice group, helping clients with transactional and business matters including mergers and acquisitions, joint ventures, corporate and limited liability company formation and governance, commercial real estate transactions, and general corporate and contractual matters.