Even during economic downturns, the U.S. economy typically has a relatively significant amount of merger, acquisition, and divestiture activity. This volume can be the result of many factors, like general company restructurings, competitors acquiring their competition, or investors simply seeing a great opportunity to take over a company. No matter what the reason, the taxation of the merger or acquisition can have a significant impact on whether or not it’s a wise move – for either side. Let’s take a look at some of the biggest examples of the many ways in which taxation affects the viability of a merger as taught in online MBA degree programs online.
Tax Attribute Carryovers
If the entity being disposed of has tax attributes, for example a high tax basis as part of its operating assets, tax credit carryovers, or Net Operating Loss Carryovers, then it’s often preferable to institute a tax-free reorganization. This can be done under IRC Section 368, or alternatively a taxable purchase and/or sale of the C Corp stock. Essentially this can limit the annual loss, and could actually limit the overall value of the operation loss. However, it’s possible that state limits could be more restrictive than federal regulations, so it’s essential to look at the big picture.
The Financing Structure
Depending on how the acquisition will be financed, a higher concentration of the buyer’s common stock or notes could provide an option for tax-free organization. It all depends on whether the acquisition is being financed with cash, notes, or the purchaser’s stock. In the case that the buyer is foreign, the debt financing could require the domestic company to withhold taxes on payments. In fact, this could also hold true in a multi-state situation. Additionally, IRC Section 163(j), often called the ‘interest stripping’ rules, could limit the amount of this year’s interest that can be deducted from taxable income. Companies with thin capitalization could be ineligible for interest deductions if part of the debt financing is re-characterized.
The Legal Status of the Acquisition
If the company to be acquired is an LLC, Partnership, or S Corp, the tax basis of the assets could be revalued through several different sections of the IRC. However, in this case, the tax burden often falls much more heavily to the seller. In order to pull it off, 80% of the seller’s stock must be sold, and unique and quite complex 338 rules come into effect. It’s essential to ensure that both the buyer and seller aren’t trying to obtain step-up or less benefits on certain assets while also trying to claim capital gains breaks on additional assets as they pertain to the corporation. If they do, then both sides could be in for a significant tax and legal hassle.
The Difference Between Ordinary and Capital Gain
When assets being sold include ‘ordinary’ income like depreciated assets or inventory, then the ordinary tax rules apply to net gains – even when they are associated with past depreciation. In the case of the sale of partnership assets or partnership interest, ordinary gains can be triggered only as far as the ‘hot assets’, like cash basis receivables, are concerned.
Purchase Price Allocation
The purchase price paid by the buyer – and any allocation price paid by the seller – is extremely important in an asset or 338 transaction. For example, if either the buyer or seller is a public company then they could be more focused on GAAP treatment, while the seller could have more flexibility around structure and purchase price allocation. To take advantage of maximum tax benefits, the seller would typically allocate as much of the sales price as possible to assets which can instead generate capital gain. Examples include land, goodwill, or other assets that have fair market values which are higher than the original tax cost. On the other hand, it’s typically in the buyer’s interest to allocate as much as possible to shorter-lived assets like machinery, equipment, prepaid expenses, or inventory, compared to goodwill or convents that are subject to amortization under Section 197.
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