Considerations for Mergers and Acquisitions — Your Clients Need to Know What to Expect
by Anand Madhusudanan, CPA, MST, Citrin Cooperman & Company, LLP –
January 19, 2018
When selling, buying or merging two or more businesses, there are various complex tax and legal issues that must be addressed, including financing structures, purchase price allocation and various tax implications. The tax impact of properly structuring the disposition and acquisition can have a very material impact to both parties. CPAs can play a vital role in helping clients make critical decisions before, during and after a merger or acquisition.
Purchase Price Allocation
Allocation of purchase price is extremely important to both the buyer and seller. The buyer will want to allocate as much of the purchase price to short-lived assets as possible in order to obtain a greater, immediate tax benefit. The buyer is allowed to record the assets purchased on the books at the fair market value of what was paid, which allows a higher tax deduction for depreciation or amortization of those particular assets. Conversely, the seller would want to allocate as much of the purchase price to assets that will create capital gain treatment, such as goodwill, customer list, non-compete agreements and land. The IRS requires the seller to recognize the sale of these assets at ordinary income rates rather than capital gains rates on items such as cash basis accounts receivable, depreciation recapture and certain inventory items.
While parties must generally report the transaction on a consistent basis, there are numerous tax planning opportunities that allow each party to obtain its specific tax and economic objectives without harming the other party.
The more common issues that should be considered when acquiring or disposing of a business entity or the underlying assets include:
- Financing Structure: How will the transaction be financed? Does the company have enough buying power to obtain financing?
- Legal status of the target: Is the acquired entity an S corporation, LLC or partnership?
- Ordinary vs. capital gain: If the assets being sold include inventory, depreciated assets or other ordinary income assets, ordinary tax rates will apply to net gains allocated with the prior depreciation allowed (or allowable).
- Sales and other transfer taxes: Since these taxes are generally applied to the gross allocations, they can often raise the cost of asset sale transactions.
- Post-transaction filing requirement/elections: Generally, a taxable asset purchase will allow the new owner to make new tax elections of accounting periods and methods, while a stock purchase or reorganization will require the new owner to continue to use the former entity’s tax elections.
A tax-free merger occurs when one company acquires a controlling interest in the other company in exchange for at least 80 percent of its stock. The main premise of Internal Revenue Code (IRC) Section 368(A) transactions is that the acquiring corporation (the “acquirer”) uses its own stock as the main form of consideration when purchasing the asset or stock of the selling corporation (the “target”). To the extent the target received no cash, gain will not be recognized and instead will be deferred. In order to qualify as a tax-free reorganization, the transaction must fall within one of the following categories:
- A statutory merger or consolidation (an “A” reorganization)
- A stock-for-stock acquisition — an acquisition by one corporation of a controlling interest in another corporation, solely in exchange for all or part of its voting stock (a “B” reorganization)
- A stock-for-asset acquisition — the acquisition by one corporation of substantially all the properties of another corporation, solely in exchange for its voting stock (a “C” reorganization)
- A reorganization in which a corporation transfers all or a part of its assets to another corporation and, immediately after the transfer, one or more of its shareholders is in control of the corporation to which the assets are transferred (a “D” reorganization)
- A recapitalization, which includes reshuffling of a corporation’s capital structure (e.g., the exchange of bonds for preferred stock) (an “E” reorganization)
- A mere change in identity, form or place of organization (an “F” reorganization)
- A bankruptcy reorganization under Title 11 of the U.S. Code or under similar laws (a “G” reorganization)
In order to qualify for any of the above, the following requirements must be met:
- There must be continuity of ownership interest.
- There must be continuity of business enterprise.
- There must be a bona fide business purpose, and not for the purpose of tax avoidance.
- The transaction must not fall under the step transaction doctrine.
- There must be a plan of reorganization.
The process of buying or selling a business can involve an extremely complex series of transactions and can greatly impact a company’s long-term financial stability. It is vital that business owners consult with their CPA or other appropriate professional during the early stages of the process in order to predict, address and solve these various issues in a timely manner.
This article appeared in the Jarnuary/February 2018 issue of New Jersey CPA magazine. Read the full issue.