Mergers and acquisitions can be a huge turning point for a business, no matter which side of the deal you’re on. There are a lot of moving parts to an M&A, and it can be easy to leave the tax planning for later — especially if you don’t already have a dedicated team to help.
But not considering taxes from the start can leave you with a much higher tax burden down the road. Tax planning should be part of your M&A strategy before the deal even starts. Incorporating tax strategy throughout your merger or acquisition — or hiring a professional to help you through it — will ensure you aren’t left paying too much once the dust settles.
Here’s what to know about tax planning for M&As before, during and after the deal.
How to structure your business before the deal
The first step to a merger or acquisition is to go through a business valuation. This helps you determine the value of your business; it also helps you form a tax strategy for how you can structure the sale.
Generally, valuators should be credentialed CPAs with the Accredited in Business Valuation (ABV) accreditation. CPAs with this accreditation have passed an exam and met AICPA standards to perform business valuations.
Valuators usually evaluate your business using one of these three methods:
- Asset-based methods base your company’s wealth on its assets minus its liabilities;
- Earning value methods base your company’s wealth on what it could produce in the future; and
- Market value methods base your company’s wealth on what similar businesses have sold for recently.
Which valuation method you choose will likely depend on the transaction structure you’re interested in, as well as your business’s specific structure and needs.
If you’re planning on restructuring your business further as part of the M&A process, a business valuation can also help you spot what parts of your company you might need to focus on.
Transaction structures: Asset vs. stock purchases
There are two main ways you can structure acquisitions: asset sales vs. stock sales. Asset sales generally favor the buyer, while stock sales tend to be better for the seller.
An acquisition’s transaction structure can be a point of contention between parties. Which one you choose will depend on what you’re hoping to get out of the sale — and what you can negotiate the other party into.
In an asset sale, a business sells off some or all of its assets, rather than selling the company outright. Asset purchases can help protect the buyer from unknown liabilities; it also gives a buyer more control over what it’s purchasing.
Asset purchases will come with different tax levels depending on if the post-acquisition company is a C corporation, S corporation or partnership. Make sure you understand the best way to structure your company before you make the deal.
In a stock sale, a company buys stock or ownership interests in another company. In doing so, it buys the company’s existing assets, but it also takes on any existing liabilities. This option tends to be a better choice for the seller, as it generally comes with a smaller tax burden for them.
What to know about Section 382 limitations and ownership changes
If you’ve experienced losses in recent years, then you’re likely already familiar with the net operating loss (NOL) deduction. If your deductions in a tax year are greater than your income, NOL lets you apply your losses to future tax years. These losses offset a portion of your income in future tax years.
If you’re currently taking advantage of NOL deductions to reduce your tax burden, be careful when going into an M&A. Section 382 of the tax code states that, if your company has a big enough ownership change, you’ll be limited in how you can utilize pre-change historical NOLs in future tax years.
Note: Section 382 only applies to C Corporations.
In order to trigger the Section 382 limitation, ownership of the loss corporation must shift significantly, with 5% shareholders collectively increasing their ownership by more than 50 percentage points over a three-year period. What that means exactly, and whether your company qualifies, can be difficult to figure out. A professional can help you figure out if this limitation applies to your company.
How to manage tax integration after the M&A
During M&A negotiations, you’ll need to determine how to allocate the purchase price to your new assets. It’s important that both you and the other party agree here; you’ll both need to report the sale to the IRS, and using different allocations in the two reports can trigger an audit.
In an asset sale, your asset allocations will determine the assets’ initial tax basis. This will help you determine the depreciation and amortization deductions for applicable assets once the acquisition goes through. In a stock sale, the tax basis of the assets transfers to the buyer. Also in a stock sale, Form 8594 is not required unless there is an election made to treat the stock sale as an asset sale for tax purposes.
Both tangible and intangible assets can qualify for depreciation and amortization deductions. Here are some examples of what to consider:
- Tangible assets: Buildings, furniture, machinery, equipment;
- Intangible assets: Customer lists, copyrights, patents, licenses.
You’ll also need to consider the ways that your business could have changed after the merger or acquisition; this can change how you handle taxes going forward. For example, if you merged with a company in a different state, you’ll need to consider how multi-state business expansion impacts your SALT tax requirements.
After a merger, your company might not qualify as a small business anymore, even if it did before. This means there might be tax benefits to owning a small business that you can’t claim anymore.
How Landmark CPAs can help you through a merger
Handling the tax requirements of a merger or acquisition can add stress to your business when you’re busy dealing with many other responsibilities. Landmark CPAs can help you through the entire M&A process, from making a deal to handling the aftermath.
Contact Landmark CPAs today to help your business get the deal it deserves.
