Both parties in an M&A transaction are looking to optimize their after-tax cash flows. Often, achieving tax savings for one party could mean increasing the tax liability for the other party. Clark Schaefer Hackett Shareholder Zach Gubser, however, says that doesn’t always need to be the case.
“Buyers and sellers in a deal should be asking how the deal structure is going to impact the counterparty,” Gubser says. “Both sides should be receptive to and understand what the other is asking for in the deal rather than focusing only on their own goals. Doing so can lead to a more favorable tax situation for everyone.”
Smart Business spoke with Gubser about tax planning for M&A deals and how thoughtful planning can create wins for both sides.
What areas affect post-deal taxes most significantly?
The structure of the deal, and whether it’s going to be an asset or equity deal from an income tax standpoint, is one of the primary ways after-tax cash flows are affected. Generally, there’s a step up in basis for the buyer when doing an asset deal, which is going to allow for the amortization or depreciation of some of the purchase price that can help recoup out-of-pocket costs over time. However, that tax benefit for the buyer could come with added tax cost to the seller. With an equity deal, certain elections could be made when both the buyer and seller agree to them, where the default would otherwise be treatment as a stock purchase and sale.
Other considerations can include the amount and the timing of the actual tax liabilities. If the seller plans to remain involved as an owner in the combined companies going forward, there are tax considerations that can apply based on how that is structured. For instance, depending on whether there will be rollover equity, participation as an employee or as an equity owner, it’s possible to defer some of the tax so the seller is not paying tax on the total sale right away.
For buyers, there could be options under Section 1202 to potentially exclude gain in the future. In some circumstances, a buyer may be willing to pay the seller a little bit more to structure the transaction in a way that it potentially leads to future tax savings. Alternatively, if a seller has NOLs or tax credits that can be absorbed or otherwise expire, the seller may be willing to recognize income without additional purchase price from the buyer.
What happens if taxes are ignored?
One clear consequence of ignoring taxes in a deal is paying more tax than necessary. That can come as a surprise when filing tax returns. Without any planning, it could mean the seller pays higher ordinary income rates rather than preferential capital gain rates. It could also mean paying tax much earlier than necessary. In either scenario, the seller is sending money off to the government that they otherwise could have enjoyed.
It’s important for sellers to start thinking about the exit as far in advance as possible. Ideally, that would include when first forming the company, as tax options such as Section 1202 require certain tax structures and that stock be acquired in specific ways. There can be provisions in the tax code that, if the person wants to do a spinoff or some other pre-transaction restructuring, they may need to wait a number of years after the restructuring is done before the next steps can be taken. Even if a seller doesn’t know how they’ll exit, having the tax aspect in mind will enable the business to maintain as much flexibility in deal negotiations as possible.
Who can help with M&A tax structuring?
Work with professional advisers — lawyers, accountants — who have experience in the M&A world. Tax consulting in an M&A transaction is very different than everyday compliance and business tax structuring, with unique issues to be addressed that someone with transaction experience can help you understand. Further, because of the complexity in an M&A transaction, both buyers and sellers should be thinking about the tax ramifications of a deal very early on, well before they plan to sell or acquire a company.
