Mergers and acquisitions can be complicated, but the water gets murkier when taxes are involved. Tax considerations are based on how an M&A deal is structured.
For both the buyer and seller in an M&A transaction, it’s important to be aware of the various tax considerations that may be associated.
The tax consequences for the buyer and seller can vary depending on the tax classification of the entity that owns the business.
Each merger and acquisition transaction can have unique tax issues, and a one size fits all approach rarely works. Although tax implications don’t dictate the deal’s overall structure, they can work in some situations.
We’ll break down what you you need to know about potential tax implications before your next M&A deal.
What is an M&A Deal Structure?
The M&A deal structure is a binding agreement between parties outlining the rights and obligations of both sides. It outlines the potential value the deal could generate for all parties involved.
This is one of the most vital parts of the M&A process; not only should parties prioritize their objectives, but they should also consider some of the risks each deal structure presents.
The 3 most common ways of structuring an M&A deal are:
- Stock Sales
- Asset Sales
Each structure has its pros and cons; buyers and sellers should carefully consider each when deciding the best route. We highly recommend consulting with an experienced M&A lawyer to help you unlock potential value and mitigate risk.
Stock Sale vs. Asset Sale
Now that you have a better understanding of what M&A deal structures are. Let’s discuss two of the most common structures, stock sales and asset sales.
The type of structure you decide to choose will determine how you will be taxed. Let’s break down some of the pros and cons of both deal structures.
In a stock sale, the buyer purchases the selling shareholder’s stock directly obtaining ownership with the selling entity.
The costs of the assets at the time of sale, or book value, sets the depreciation basis for the new owner.
As a result, the lower depreciation expense can result in higher future taxes for the buyer, as compared to an asset sale.
Additionally, buyers may accept more risk by purchasing the company’s stock, including all contingent risks that may be unknown or undisclosed.
Sellers tend to prefer stock purchases because all the proceeds are taxed at a lower capital gains rate. This structure also lowers the seller’s chances of being responsible for any future liabilities that may occur.
In an asset sale, the buyer purchases individual assets of the company while the seller maintains ownership of the entity.
Buyers may be interested in purchasing assets such as licenses, equipment, trade names, etc. Asset sales are commonly referred to as cash-free debt transactions.
Asset sales are typically more beneficial to buyers for several reasons. Purchasing only assets can produce additional tax benefits for the buyer which may result in a bump in cash flow.
This deal structure also lowers the buyer’s chances of inheriting potential liabilities. For sellers, this deal structure may potentially generate higher income tax rates.
Conducting Tax Due Diligence
Before a company decides which deal structure to move forward with, it should first conduct proper tax due diligence.
One of the most important steps in the M&A process is understanding the implications of the transaction and how it can affect your company, positively or negatively.
Tax due diligence is the detailed assessment of all the taxes that a company will become liable for during an M&A transaction.
This entails taking a deep dive into the target company’s current tax structure and the implications that may come along with it.
For example, if Company A is interested in acquiring Company B, Company A may review previous IRS tax audits, and federal and state income tax returns to ensure there aren’t any unknown liabilities that may arise once the deal is in motion.
If you’re on the buyer side of the deal, it’s important not to skip this step.
Conducting tax due diligence allows a buyer to make informed decisions and determine whether it’s worth moving forward with the deal.
We highly recommend consulting with an experienced M&A attorney to help make sure you’ve checked all the right boxes!
Considering Buying or Selling a Business? We Can Help!
Whether you’re selling your business or expanding your empire by acquiring a new company, it’s best to have a knowledgeable attorney on your side.
We’ve helped our clients navigate through the tumultuous process of an M&A transaction while keeping their best interests in mind!
The only way to avoid any unexpected obstacles is to be informed of all of the implications of the M&A deal and what they may mean for your company.