Mergers and acquisitions (M&A) can be an effective strategy for companies to grow, acquire new technologies, capture market share, or seize opportunities. However, the structure of a proposed deal can have significant tax consequences at the federal and perhaps state level that must be considered to maximize value and cash flow from the transaction. Seller and buyer may gain different advantages depending on how the deal is put together, so it is essential to understand the possible tax implications of various proposals to create a solution that is satisfactory to all parties.
Federal Tax Treatment
Under federal law, a merger or acquisition may be considered a tax-free reorganization under Internal Revenue Code §368 or a taxable transaction under IRC §1001, based on how it is structured. For federal tax purposes, the term “corporate restructuring” as defined in IRC §368 encompasses a range of different corporate transactions, including one corporation acquiring the stock or assets of another company, a single corporation adjusting their capital structure, or a single corporation dividing into one or more entities. For participating companies and their shareholders to receive favorable tax treatment, a reorganization must meet several statutory and common law requirements.
When a company is acquired, if the acquired company receives only stock, securities, or both in a corporation that is a party to the reorganization, it recognizes no gain or loss upon the exchange if it distributes such stock and/or securities to its shareholders. If it receives other cash or other property (boot) in the reorganization, the acquired company recognizes gain to the extent of the boot if it is not distributed to its shareholders.
Generally speaking, when an acquiring company issues stock in exchange for the property of an acquired company, it recognizes no gain or loss. Similarly, assuming the liability of an acquired company is usually not treated as the payment of cash and is not recognized as a gain.
The Effect of Tax Classification of the Target Business Entity
For buyer and seller, the tax implications of the acquisition of a target business vary depending on whether the business entity that owns it is a disregarded entity, C corporation, S corporation, or partnership. In the case of an acquisition of a business owned in corporate form (C corp or S corp), the buyer and seller are likely to have different preferences.
If the selling shareholder(s) of the target company sell stock, as a matter of law the buyer assumes all of the liabilities of the target corporation. This is not generally true if the buyer buys the assets of that business instead. Additionally, buyers tend to prefer buying assets because they can pick and choose which assets to purchase.
Sellers may also prefer to sell stock due to certain tax advantages. When the target company is a C corp, selling shareholders can avoid the two levels of tax that usually apply when corporate assets are sold and their proceeds distributed to shareholders. When the target company is an S corp, selling shareholders are taxed at capital gains rates, generally, and may be subject to lower state and local taxes. A stock sale does not trigger the built-in gains tax in IRC § 1374 (if it is done without a §338(h)(10) or 336(e) election).
Buyers, conversely, can gain benefits through buying assets by obtaining a fair market value basis in those acquired assets. To obtain a fair market value basis in acquired stock, a §338(h)(10) or 336(e) election would need to be made. A buyer may also be able to claim bonus depreciation for the amount of the purchase price that can be allocated to certain tangible depreciable property. For qualified property acquired and put into service after September 27, 2017, and before January 1, 2023, the expensing percentage is 100%. That percentage is phased down for property placed in service between 2023 and 2027.
When the buyer and target company are both corporations, it may be possible to structure the acquisition as a tax-free transaction. However, that may not be preferred if the shareholders have a loss or minimal gain on the target shares. If receiving a stepped-up basis in the target company’s assets is a priority for the buyer, that may also influence the preferred deal structure.
These are only some of the tax considerations that can come into play in M&A transactions. It is essential to consult an experienced M&A law firm to analyze the opportunities in your proposed deal, take full advantage of available tax efficiencies, and enhance the value of your transactions.
Expertise and Experience in Domestic and International Mergers and Acquisitions
The expert legal team at Bridge Law LLP understands that crafting a successful M&A deal has myriad facets, including minimizing tax liability. We provide the highest quality legal services for your domestic or international transaction. We’re here to protect your interests and provide your business with the assistance it needs at every stage of growth. To learn more, contact us here to schedule your consultation.