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Tax Considerations in M&A Toolkit
Practical Law Toolkit w-005-6471 (Approx. 9 pages)
Tax Considerations in M&A Toolkit
by Practical Law Corporate & Securities
| Maintained • USA (National/Federal) |
A collection of resources to assist counsel in analyzing the tax considerations for mergers and acquisitions.
The tax treatment for the seller and buyer is typically a primary consideration in negotiating the structure of the purchase of a business. The acquisition of a business generally takes the form of either:
- A purchase of the target company's assets.
- A purchase of equity interests in the target company (stock, partnership, or LLC interests).
- A direct or indirect merger with the target company.
When analyzing the tax consequences of an acquisition, it is important to understand the tax classification of the business entity that owns the target business and, in particular, whether the business is owned by a:
- Disregarded entity.
- Partnership.
Tax consequences for the buyer and seller of a business vary depending on the tax classification of the business entity that owns the business. For example, the acquisition of all of the interests in an LLC that is treated as a disregarded entity is treated as the sale and purchase of the assets owned by the LLC (Rev. Rul. 99-5).
There is a fundamental tension between the seller and buyer in an acquisition of a business owned in corporate form (by a C-corporation or S-corporation). The selling shareholder or shareholders of the target company generally prefer to sell stock because:
- The buyer assumes all the liabilities of the target company as a matter of law.
- For a target company organized as a C-corporation, the selling shareholders can avoid the two levels of tax that generally apply to the sale of corporate assets followed by a distribution of sales proceeds to shareholders.
- For a target company organized as an S-corporation, the selling shareholders generally are taxed at capital gains rates and may be subject to lower state and local taxes, and a stock sale (without a Section 338(h)(10) or 336(e) election) does not trigger the built-in gains tax in IRC Section 1374.
The buyer generally prefers to buy the assets of a business organized in corporate form because the buyer:
- Can pick and choose which assets to buy.
- Does not generally assume the corporation's liabilities as a matter of law.
- Can obtain a fair market value basis in the acquired assets (although it may be able to buy stock and obtain a fair market value basis in the acquired assets if an IRC Section 338(h)(10) or 336(e) election is made). The buyer may be able to claim bonus depreciation for the portion of the purchase price allocable to certain tangible depreciable property (100% for qualified property acquired and placed into service after September 27, 2017, and before January 1, 2023, with the expensing percentage phased down for property placed in service from 2023 to 2026).
If the target company and buyer are both corporations, the parties may consider whether it is possible or desirable to structure the acquisition as a tax-free transaction. Even if a tax-free transaction is possible, it may not be desirable if the shareholders have a loss or little gain on the target shares or the shareholders are largely tax indifferent (for example, tax-exempt or foreign shareholders of a C-corporation). The buyer may also prefer a transaction structure that results in a stepped-up basis in the target company's assets. In addition, private company stock acquisitions are generally structured as taxable acquisitions.
A buyer of an interest in an entity taxed as a partnership can achieve a basis step-up in the buyer's share of partnership assets through an IRC Section 754 election. The election is made at the partnership level. If the buyer acquires 100% of the interests in an entity taxed as a partnership, it is treated as buying assets directly from the entity's former owners (Rev. Rul. 99-6).
This Toolkit contains continuously maintained resources designed to assist counsel in analyzing the relevant tax considerations in the acquisition of a business.