Tax structures in the purchase or sale of a business
Whether you are buying or selling your business, tax issues can complicate every transaction. Find a transaction structure that meets the needs of both buyer and seller, achieve an increase in the tax base, and determine if and how net operating losses, carryforwards and other tax attributes can be used are complex problems that must be solved.
Most transactions involving the buying and selling of a business can be organized into two categories: a sale of assets or a sale of shares. Structuring the transaction as a sale of assets will have different tax ramifications than structuring the transaction as a sale of shares, and both parties should appreciate and be aware of the differences.
Sale of assets
When selling assets, the buyer has the option of buying all of the assets and liabilities or specific assets – and assuming certain liabilities – of a target company. This requires the buyer and seller to take over / transfer all acquired assets to the buyer.
After an asset sale, the seller retains ownership of the legal entity, which has the cash from the sale, and excludes the assets and liabilities that were not sold in the transaction.
The seller will also need to provide a sufficient level of working capital to operate the business, which tends to be a negotiated item.
Advantages and disadvantages of an asset sale
Buyers generally prefer asset sales because they can increase the base of acquired assets, such as equipment and goodwill, which provides a future tax advantage through higher depreciation expenses, such as depreciation. bonus, resulting in higher after-tax cash flow for the buyer. Due to the desire for higher after-tax cash flow, buyers may pay a higher purchase price.
Another reason buyers generally prefer asset transactions is that they can generally avoid certain liabilities that may not have been discovered during due diligence. It is also possible that a liability may emerge later that could not have been known during due diligence, such as lawsuits, for example.
While a sale of assets may be good for the buyer, the seller may have unfavorable tax consequences. The negative consequences are determined by whether the selling company is an S or C company, the asset price allocation and other facts and circumstances.
The main disadvantage for a seller is that a sale of assets may result in higher taxes, as part of the proceeds from the sale of the transaction will be treated as ordinary income rather than capital gains. For this reason, sellers generally prefer a sale of shares, at least from a tax perspective. However, if a seller’s company has a significant goodwill component, the tax differences may not be materially different.
Since each asset is assumed to be purchased separately, each will have its own tax rate depending on the type of asset it is. This often results in a mixture of regular income and capital gains.
Sale of shares
When buying shares, the buyer buys shares in a target company.
Advantages and disadvantages of a stock sale
In most cases, the seller is motivated to structure the transaction as a sale of shares. However, if there are any contracts or other assets that the company cannot easily transfer / rename that are needed, the buyer would be motivated to structure the deal as a sale of shares.
There are many ways that a buyer and a seller can structure a market transaction, and the consequences for each can be quite different. However, the most common are:
- A sale where the buyer and the seller make a article 338 (g) election
- A sale where the buyer and seller make an election under section 338 (h) (10)
Article 338 (g) Choice
An election under section 338 (g) allows an acquisition of shares to be treated as an acquisition of assets for tax purposes. This causes the transaction to have the same tax effects for an asset acquisition, such as creating a base increase in assets and double taxation. The main advantage is that all recognized assets and intangible assets, including goodwill, become tax deductible. However, the choice also results in two levels of taxation at the corporate and shareholder level, with an immediate gain recognized for the increase in the base. The choice only makes sense when the present value of future tax savings exceeds the current tax cost of increasing the tax base.
The following conditions apply to the election provided for in Article 338 (g):
- Buyer must be a C company
- The target must be a company C
- The buyer must buy at least 80% of the target’s shares
- The buyer unilaterally makes the choice
- The buyer bears the tax burden of the gain on the deemed sale of the target’s assets
338 (H) (10) Election
An election under section 338 (h) (10) allows the buyer and seller to enter into a contract to purchase shares that generally does not require a transfer or consent for the transfer of assets. . However, the election says the IRS will not recognize the transaction as a sale of shares, but the IRS will treat it as if the buyer had purchased the assets and liabilities of the target company.
This has the same tax consequences as a sale of assets, as discussed above.
The seller can have a mixture of capital and ordinary income and the buyer gets a raised base in the assets of the company. An election under section 338 (h) (10) might be an attractive option for a seller if it was an S-Corporation with a large component of goodwill and certain contracts or leases that might be difficult. to transfer.
The following conditions apply to the election provided for in Article 338 (h) (10):
- Buyer must be a C company
- The target must be
- A US subsidiary of a group of affiliates or a consolidated group, or
- An S company
- Both buyer and seller agree to make the choice
Whatever route or strategy you take to structure your transaction, keep in mind that buying and selling a business is complicated and you should consult a tax expert first.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Mark Gallegos, CPA, MST, is a tax associate on the Porte Brown Accounting and Consulting Services team in the Elgin, Illinois office. He has over 20 years of experience. He spends a lot of time advising, speaking and writing on international taxation, mergers and acquisitions, credits and incentives. Gallegos has been steeped in the intricacies of tax law and impending changes. Gallegos co-hosts a series of recurring webinars on the subject and speaks regularly on tax law and other tax matters.
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