Every merger or acquisition (M&A) will have specific tax implications for the business and its owners. Given the complexity and potentially unexpected costs involved, mergers and acquisitions tax planning in the early stages of your deal is vital—regardless of whether you’re buying or selling. Taking these steps now allows you to leverage the financial advantages of a well-structured M&A deal.
Understanding the M&A Landscape
The M&A (Mergers and Acquisitions) process involves combining companies through a deal between the seller (often referred to as the target) and the buyer. You might be considering M&A as a strategic move to:
- Achieve growth
- Diversify
- Exit the market
- Synergize your presence and offerings across industry segments
- Enhance competitiveness
- Monetize the company you’ve built
Consider your goals to build an M&A deal structure that works in your best interest. Proactive mergers and acquisitions tax planning is crucial in optimizing financial outcomes.
The M&A process typically includes:
- Identifying the target (business) you want to buy (or sell)
- Getting your accounting and financial statements in order
- Obtaining audit or assurance to increase mutual trust
- Getting a business valuation
- Negotiating terms
- Conducting due diligence through M&A Services
- Finalizing the deal
- Seeking M&A business advice from various advisors throughout the process
Tax Strategies for Business Sellers
To optimize financial outcomes when selling a business, it’s crucial to consider various tax strategies that can significantly affect your net proceeds. These strategies can help minimize tax liabilities and maximize returns. Here are some effective methods to consider:
- Utilize capital gains tax rates: By leveraging favorable tax rates for long-term investments, sellers can reduce the amount of taxes owed on the profit from the sale. This approach encourages long-term investing and can result in substantial tax savings.
- Sell to an Employee Stock Ownership Plan (ESOP): ESOPs offer a unique opportunity for business sellers to transition ownership to their employees while potentially benefiting from tax advantages. This method not only supports employee engagement and investment in the company’s success but can also provide a tax-efficient exit strategy for owners.
- Take advantage of exemptions: Certain exemptions, like the Section 1202 Qualified Small Business Stock exemption, allow eligible small businesses to exclude from taxation a portion, or in some cases, all of their capital gains from the sale of stock. This can lead to significant tax savings, making it a highly beneficial strategy for qualifying businesses.
Incorporating the right tax strategies into your plan can lead to more favorable tax treatment and enhance the overall financial benefits of the transaction.
Tax Considerations for Business Buyers
One strategy here is to prioritize assets with favorable tax treatment. When you buy a company, you split the price among its assets. You could allocate more toward tangible assets that depreciate or amortize quickly. You get those tax savings sooner rather than later.
Alternatively, you might want to think long-term about lowering your tax liability over many years. In that case, you might allocate the purchase price more toward intangibles like patents and trademarks.
This is just one example of how strategic tax structuring can lead to cost savings, enhance cash flow, and improve overall deal economics.
Moreover, effective tax planning also helps mitigate risks when buying and ensures a smoother integration process, contributing to the long-term success of the merged entities.
Common M&A Structures and Their Tax Implications
- Standard merger — This structure allows you to consolidate companies through stock or asset acquisitions. Tax implications vary for each structure, but standard mergers generally trigger capital gains tax.
- Triangle merger — This structure includes a subsidiary of the acquiring company merging with the target company while maintaining each as a distinct legal entity. This type can avoid transfer taxes when done correctly.
- Reorganization merger — This one involves various forms of structural changes. You might choose the type to earn tax-free status, but ensuring your deal qualifies is vital.
Expert merger and acquisition tax planning is crucial to optimize outcomes in each scenario.
Special Tax Considerations
In M&A, considering Net Operating Losses (NOLs) and Goodwill is essential.
Harness the power of NOLs to offset taxable gains. If the company you’re buying has suffered NOLs in the past, purchasing this business means you’re buying the right to reduce future years’ taxable income to offset those losses. This sounds easy, but your deal structure will determine whether or not you can do this as outlined in Section 382 of the US Tax Code.
Goodwill’s treatment affects the overall deal value and represents the influence the brand has on meeting its business goals. It’s an integral part of coming to a fair price, but it can also impact taxes. Goodwill acquired in a stock sale is not tax deductible or amortizable. However, in an asset sale, it is tax-deductible.
Your deal structure can significantly alter the handling of these for or against your interest, further showcasing the importance of M&A tax planning.
Timing of an Acquisition and Its Tax Impact
The timing of an acquisition significantly impacts tax liabilities. To continue previous examples, consider your company is acquiring another with substantial Net Operating Losses (NOLs). You would want to buy the company before they can offset future income with those losses. If you’re the seller, the opposite is true.
In another example, the company plans to sell a significant asset, generating capital gains. If the company completes the sale before implementing new tax regulations that lower capital gains rates, it could reduce its tax liabilities.
Choosing the Right M&A Structure
What does a tax-efficient deal structure look like? It depends on your goals.
A stock sale is when you sell ownership interest and is preferable for the seller. As the seller, you’re only taxed at the shareholder level, and it’s not treated as ordinary income. As the buyer, your basis is the stock price you do not recover until you sell/liquidate that stock. You also assume specific liability from the seller unless otherwise negotiated.
Asset purchase consists of selling the company’s assets and is preferable for the buyer because the tax basis is the fair market value of the assets. And we’ve already discussed asset allocation advantages when doing so.
If you’re the seller, the tax burden can be cost-prohibitive, but you have ways to offset this with proper mergers and acquisitions tax planning.
How DHJJ Can Help
DHJJ has the mergers and acquisitions tax planning and advisory services to navigate to help maximize your returns. We are a full-service M&A advisory and accounting firm. Given the complexity, it’s critical to seek professional assistance when buying or selling a business of any size.
