tax minimization in mergers &...
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TAX MINIMIZATION IN MERGERS & ACQUISITIONS
Harold F. Ingersoll, CPA/ABV/CFF, CVA, CM&AA
Stock/Interest
Asset
Reason is to transfer non-assignable contracts and liabilities
Can be treated like an asset deal, Sec. 338 (h)(10) for C Corps and Sec. 336(e) for S Corps.
• If election is made, then options are the same as the asset deal. (Discussed later.)
C Corporations Only
Avoid taxes using Sec. 1202
If Qualifying Small Business Stock (QSBS)
Exclusion of gain up to $10m.
Some reductions if original stock purchased before2/17/2009.
QSBS must have always been taxed as a CCorporation (could never have been anything else).
Stock held must be original issue stock.
Assets cannot exceed $50m.
Must hold original stock for 5 years or more.
Defer taxes using Sec. 1045
If Qualifying Small Business Stock (QSBS)
Unlimited amount of gain can be deferred.
Must be rolled over into another QSBS within 60 days of sale.
Must have held the QSBS only 6 months prior to sale.
All Corporations (C&S)
Defer taxes
• Reorganization/Mergers:
• Forward or reverse triangular mergers
• Other merger types
• If outright sale by individual, profit is capital gains
• ( Usually no Texas Franchise taxes )
Partnerships and LLCs
Interest sale
Capital gains to selling partners on all except Hot Assets.
Hot assets are primarily accounts receivable and inventory, these may be taxed as ordinary income.
Taxes can be deferred if Section 721 is used.
• ( Usually no Texas Franchise taxes )
Reason is to leave seller liabilities with the seller.
Usually, all assets (except cash) and potentially accounts receivable & accounts payable.
Buyer may assume some specific liabilities.
Gain taxation depends on allocation of purchase price to specific asset classes.
Type of entity makes a hugedifference.
C Corporations All gains recognized are taxed at ordinary income tax rates regardless of
the character (capital/ordinary).
To get funds out of the corporation, the shareholders receive a bonusor taxable dividend. If the gains are too large, bonuses become difficultdue to reasonable compensation issues. If dividend, it is double taxed.Maximum rate at corporation is 35%, then at individual level is 23.8%,total maximum rate of 58.8% if paid out as dividend.
If there is significant personal goodwill owned by the sellingshareholder which can be justified, the buyer can purchase thepersonal goodwill directly from the seller. This creates capital gains forthe seller outside of the corporation that are taxed at maximum rate of23.8%.
S Corporations & Partnerships Gains depend on how the purchase price is allocated:
Seller motivated to allocate more to intangibles, such as goodwill, which will be taxed as capital gains.
Buyer motivated to allocate as much to tangible assets (furniture, equipment, etc…) as possible to get quicker tax write off. Good news is even intangibles get the tax benefit. It just takes 15 years to get the benefit.
If proceeds need to be allocated disproportionately or contrary to allocation protocol, they can be directed outside of the entity directly to the owners for their personal goodwill, if it can be justified. Taxes are the same, but are proceeds are directed to different owners.
C CORPORATION: Gain $1,000,000 Corporate tax None Individual tax:
If §1202 None on potentially first $10m If §1045 Potentially none If neither $238,000
S CORPORATION: Gain $1,000,000 Corporate tax None Individual tax:
If merger None on amount swapped for buyer stock If neither $238,000
(Does not take AMT into consideration)
PARTNERSHIP: Gain $1,000,000
Individual tax:
If merger None on amount swapped for buyer int.
If neither $238,000
(Does not take AMT into consideration)
C CORPORATION: Gain $1,000,000 Corporate tax:
Franchise tax $ 7,500 Income tax $ 350,000
Individual tax: If dividend paid of $650k $ 154,000 Total taxes $ 511,500
S CORPORATION: Gain $1,000,000 Corporate :
Texas Franchise Tax $ 7,500 Income tax None
(if never been a C corp) Individual tax: $ 238,000 Total taxes $ 245,500
(Does not take AMT into consideration)
PARTNERSHIP:
Gain $1,000,000
Franchise tax $ 7,500
Individual tax: $ 238,000
Total taxes $ 245,500
(Does not take AMT into consideration)
1. If entity is a C Corporation consult with someone about thequalification for Sec. 1202 and 1045 to see if qualified.
If so, consider the possibilities of a stock deal in a future sale.
If a stock deal is not likely, then consider making an S election.
If S election made, in 5 years the gain on any sale will be taxed as an assetdeal from an S corporation, avoiding double tax on all gains in excess ofremaining C Corporation Earnings and Profits.
2. When structuring a new business consider the possible exitstrategies before selecting an entity type.
If likely to be a stock/interest deal, then consider being a C Corporation fromthe start so as to qualify for Sec. 1202 and 1045.
If more likely to be an asset deal then consider S Corporation orPartnership/LLC structure.
Partnership/LLC offers more flexibility in ownership structure than an SCorporation.
Venture capital, angel and private equity investors are becoming moreaccepting of pass through entities in acquisitions.
3. When structuring ownership of intellectual property, goodwill, real estate, and othertangible assets, plan the most effective manner of holding the property.
Will IP be held in a separate entity and then licensed to the operating entity and a royalty bepaid? This way IP can be licensed to others without impairing the value of the operating entityor the IP.
Will the company execute non-compete agreements with the shareholder/employees? If so,they are creating more value for the company, but reducing the possibility of allocatingpurchase price to personal goodwill of the owners, thus minimizing tax planning opportunitiesin structuring a future deal.
Will real estate owned by the company be attractive to a potential buyer? If potentially not,consider placing in a separate entity and charge rent to the operating entity. This will facilitatethe better possibility of negotiating a stock or interest deal when sale time comes.
Will equipment or other fixed assets be owned by the company or a separate company andleased back to the operating company? This may be attractive to segregate liability associatedwith heavy equipment and may facilitate a stock/interest deal in the future for a buyer thatdoes not want the equipment.
This is a very complicated area of the law andrequires knowing the market place in which thecompany is operating and planning for it. Themarket changes continually, so the planning needsto change also.
Many of the issues discussed in thispresentation have significant legalimpact in addition to income taximpact. I am not an attorney andany discussion of liability or legalstructure issues need to be discussedwith an attorney prior to decisionmaking.
Any EASY questions?
Harold Ingersoll, Partner, CPA/ABV/CFF, CVA, CM&AA
Atchley & Associates, LLP
1005 La Posada Drive
Austin, Texas 78752
(512) 346-2086; (512) 338-9883 fax
www.atchleycpas.com