Tax Considerations for M&A Transactions

Key insights:

  • The tax implications of a merger or acquisition should always be a primary consideration in negotiating the structure of a deal and purchase price.
  • Tax due diligence is a thorough investigation into the different types of taxes that might impact the transaction and identify potential deal-breakers.
  • It’s particularly important to identify the target company’s current and projected tax liabilities and consider how they will be reflected in the deal.

Mergers and acquisitions (M&A) may have ground to a halt in early 2020 but have since rebounded in a big way. Morgan Stanley predicts that economic recovery, affordable access to capital, and corporate interest in global expansion will continue to drive M&A activity through 2021 and beyond.

However, the tax implications of an M&A transaction should always be a primary consideration in negotiating the deal’s structure and purchase price. In many cases, it can even impact whether the deal ultimately goes through at all.

If you are considering an acquisition or sale in the coming year, it is crucial to consider the tax implications.

Understanding Types of Acquisitions

Generally, there are two options for structuring a transaction, each with unique tax benefits for buyers and sellers.

  1. Asset purchase. The buyer may purchase specific assets and liabilities of the business, including equipment, furniture and fixtures, real property, inventory, payables and receivables, goodwill, trade names, and more. Once the transaction is complete, the assets and liabilities are moved to the new entity, and the old entity is wound down. In an asset purchase, the seller retains ownership of the legal entity.
  2. Stock purchase. A buyer may purchase the seller’s stock or ownership interest in the company, thereby obtaining ownership in the seller’s legal entity. The assets and liabilities acquired in a stock purchase tend to be similar to that of an asset purchase. However, stock sales do not require numerous separate conveyances of individual assets and liabilities because ownership remains with the corporation.

Tax Due Diligence

Standard due diligence as part of an M&A transaction involves confirming pertinent information about the assets or company to be acquired, including contracts, pending and potential lawsuits, customers, compensation agreements, and more.

Tax due diligence is a thorough investigation into the different types of taxes that might impact the transaction and helps to identify potential deal-breakers. 

Due diligence isn’t just for buyers. Sellers should also consider performing tax due diligence proactively. According to McKinsey, 73% of M&A deals are terminated or canceled due to price expectations, regulatory concerns, and political headwinds. When sellers conduct tax due diligence on their own organization, they have an opportunity to identify gaps and resolve issues before the buy-side gets involved.

Some of the areas considered during tax due diligence include:

  • Understanding the target company’s existing tax structure
  • Understanding the expected structure of the transaction
  • Reviewing the target company’s historical tax compliance
  • Identifying any existing tax exposures

It’s particularly important to identify current and projected tax liabilities of the target company and consider how they will be reflected in the deal. This includes federal income tax, state and local income tax, and payroll tax, as well as sales and use tax liabilities.

The target company’s expansion into new locations or markets can impact physical and economic nexus in multiple sales tax jurisdictions. Therefore, it’s crucial to consider these potential undisclosed tax liabilities in the transaction.

Tax Benefits of the CARES Act

The Coronavirus Aid, Relief, and Economic Security (CARES) Act can significantly impact M&A transactions.

Some of the areas to consider include:

  • Deferral of payroll taxes. The CARES Act allowed employers to defer their portion of Social Security payroll taxes from March 27, 2020, through December 31, 2020. Of that amount, 50% could be deferred until December 31, 2021, and the remaining 50% could be deferred until December 31, 2022. When acquiring a company that benefited from this provision, buyers should ensure these liabilities are accounted for in the transaction.
  • Net operating loss (NOL) adjustments. The CARES Act allowed companies with NOLs from 2018 through 2020 to carry back NOLs to the prior five taxable years and lifted the 80% income limit on claiming NOLS for tax years beginning before 2021. Buyers negotiating M&A agreements should ensure that the tax refund provision, which normally provides for the payment of pre-closing tax period refunds to the seller, allows the buyer to carry back NOLs and retain any refund resulting from NOL carrybacks.

Minimizing Income Tax Implications for Sellers

Ensuring the transaction is structured in a tax-efficient manner is key to maximizing a seller’s after-tax proceeds.

Sellers tend to prefer stock sales for tax purposes. Stock sales are generally treated as long-term capital gains (assuming the seller has held their interest in the company for more than one year). As such, they are taxed at a top tax rate of 20%, plus a potential additional 3.8% net investment income tax (NIIT).

On the other hand, asset sales can generate a combination of ordinary income (currently taxed at a top rate of 37%) and capital gains.

Evaluating the structuring alternatives before beginning the formal sale process provides several benefits. First, it enables the seller to identify the preferred structure and set expectations with prospective buyers at the onset of the process. Second, understanding the tax implications allows the seller to anticipate how the buyer may view a proposed transaction structure. Finally, it permits the seller to assess whether they might be in a position to negotiate a higher price if conceding to a deal structure that is more favorable to the buyer.

How Holtzman Can HelpTax Advisory

The merger and acquisition marketplace continues to evolve. The information in this article is a starting point for determining the transaction tax implications of an M&A deal. However, there are a variety of other considerations, including the deductibility of transaction costs, the rollover of a seller’s equity, and more. Due to the complexity of the tax ramifications of an acquisition or sale, having a trusted tax advisor on your side is imperative. Contact our Tax Services team for help analyzing potential transactions or download our Tax Due Diligence Diagnostic datasheet to learn more about services.

Service expansion announcement: Holtzman is becoming Armanino effective January 1, 2022.

By joining together, Holtzman clients will have access to an expanded suite of accounting and consulting offerings to support any stage of company growth. Armanino’s Tax practice, with its deep bench, can provide on-demand expertise on a multitude of issues, including international tax, state and local tax, transfer pricing, R&D tax credits, transaction advisory, provision, estate and trust, partnerships and qualified business income. Learn more in our press release.

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