TAX MIN INIMIZATION IN IN MERGERS & ACQUISITIONS Harold F. - PowerPoint PPT Presentation

TAX MIN INIMIZATION IN IN MERGERS & ACQUISITIONS Harold F. Ingersoll, CPA/ABV/CFF, CVA, CM&AA

 Stock/Interest  Asset

Reason is to transfer non- assignable contracts and liabilities Can be treated like an asset deal, Sec. 338 (h)(10) for C Corps and Sec. 336(e) for S Corps. • If election is made, then options are the same as the asset deal. (Discussed later.)

C Corporations Only Avoid taxes using Sec. 1202 De Defer taxes using Sec. 1045 If Qualifying Small Business Stock (QSBS) If Qualifying Small Business Stock Exclusion of gain up to $10m. (QSBS) Some reductions if original stock purchased before Unlimited amount of gain can be 2/17/2009. deferred. QSBS must have always been taxed as a C Corporation (could never have been anything else). Must be rolled over into another QSBS Stock held must be original issue stock. within 60 days of sale. Assets cannot exceed $50m. Must have held the QSBS only 6 Must hold original stock for 5 years or more. months prior to sale.

All Corporations (C&S) Defer taxes • Reorganization/Mergers: • Forward or reverse triangular mergers • Other merger types • If outright sale by individual, profit is capital gains • ( Usually no Texas Franchise taxes )

Partnerships and LLCs In Interest sale le Capital gains to selling partners on all except Hot Assets. Hot assets are primarily accounts receivable and inventory, these may be taxed as ordinary income. Taxes can be deferred if Section 721 is used. • ( Usually no Texas Franchise taxes )

Reason is to leave seller liabilities with the seller . Usually, all assets (except cash) and potentially accounts receivable & accounts payable. Buyer may assume some specific liabilities. Gain taxation depends on allocation of purchase price to specific asset classes. Type of entity makes a huge difference.

 C Corporations  All gains recognized are taxed at ordinary income tax rates regardless of the character (capital/ordinary).  To get funds out of the corporation, the shareholders receive a bonus or taxable dividend. If the gains are too large, bonuses become difficult due to reasonable compensation issues. If dividend, it is double taxed. Maximum rate at corporation is 35%, then at individual level is 23.8%, total maximum rate of 58.8% if paid out as dividend.  If there is significant personal goodwill owned by the selling shareholder which can be justified, the buyer can purchase the personal goodwill directly from the seller. This creates capital gains for the seller outside of the corporation that are taxed at maximum rate of 23.8%.

 S Corporations & Partnerships  Gains depend on how the purchase price is allocated:  Seller motivated to allocate more to intangibles, such as goodwill, which will be taxed as capital gains.  Buyer motivated to allocate as much to tangible assets (furniture, equipment, etc…) as possible to get quicker tax write off. Good news is even intangibles get the tax benefit. It just takes 15 years to get the benefit.  If proceeds need to be allocated disproportionately or contrary to allocation protocol, they can be directed outside of the entity directly to the owners for their personal goodwill, if it can be justified. Taxes are the same, but are proceeds are directed to different owners.

C CORPORATION:  Gain $1,000,000  Corporate tax None  Individual tax:  If §1202 None on potentially first $10m  If §1045 Potentially none  If neither $238,000  S CORPORATION:  Gain $1,000,000  Corporate tax None  Individual tax:  If merger None on amount swapped for buyer stock  If neither $238,000  (Does not take AMT into consideration)

 PARTNERSHIP:  Gain $1,000,000  Individual tax:  If merger None on amount swapped for buyer int.  If neither $238,000 (Does not take AMT into consideration)

C CORPORATION:  Gain $1,000,000  Corporate tax:  Franchise tax $ 7,500  Income tax $ 350,000  Individual tax:   If dividend paid of $650k $ 154,000 Total taxes $ 511,500  S CORPORATION:  Gain $1,000,000  Corporate :  Texas Franchise Tax $ 7,500  Income tax None  (if never been a C corp) Individual tax: $ 238,000  Total taxes $ 245,500  ( Does not take AMT into consideration)

 PARTNERSHIP:  Gain $1,000,000  Franchise tax $ 7,500  Individual tax: $ 238,000 $ 245,500  Total taxes (Does not take AMT into consideration)

1. If entity is a C Corporation consult with someone about the qualification for Sec. 1202 and 1045 to see if qualified.  If so, consider the possibilities of a stock deal in a future sale.  If a stock deal is not likely, then consider making an S election.  If S election made, in 5 years the gain on any sale will be taxed as an asset deal from an S corporation, avoiding double tax on all gains in excess of remaining C Corporation Earnings and Profits.

2. When structuring a new business consider the possible exit strategies before selecting an entity type.  If likely to be a stock/interest deal, then consider being a C Corporation from the start so as to qualify for Sec. 1202 and 1045.  If more likely to be an asset deal then consider S Corporation or Partnership/LLC structure.  Partnership/LLC offers more flexibility in ownership structure than an S Corporation.  Venture capital, angel and private equity investors are becoming more accepting of pass through entities in acquisitions.

3. When structuring ownership of intellectual property, goodwill, real estate, and other tangible assets, plan the most effective manner of holding the property.  Will IP IP be be held in in a separate entity and then licensed to to the operating entity and a royalty be be paid? This way IP can be licensed to others without impairing the value of the operating entity or the IP.  Will the company execute non-compete agreements with the shareholder/employees? If so, they are creating more value for the company, but reducing the possibility of allocating purchase price to personal goodwill of the owners, thus minimizing tax planning opportunities in structuring a future deal.  Will real estate owned by by the company be be attractive to to a potential buyer? If potentially not, consider placing in a separate entity and charge rent to the operating entity. This will facilitate the better possibility of negotiating a stock or interest deal when sale time comes.  Will equipment or or other fi fixed assets be be owned by by the company or or a separate company and leased back to to the operating company? This may be attractive to segregate liability associated with heavy equipment and may facilitate a stock/interest deal in the future for a buyer that does not want the equipment.

 This is a very complicated area of the law and requires knowing the market place in which the company is operating and planning for it. The market changes continually, so the planning needs to change also.

 Many of the issues discussed in this presentation have significant legal impact in addition to income tax impact. I am not an attorney and any discussion of liability or legal structure issues need to be discussed with an attorney prior to decision making.

Any EASY questions?

Har arold ld In Ingersoll, ll, Par artner, CPA/ABV/CFF, CVA, A, CM&AA Atchley & Ass ssocia iates, LLP LLP 10 1005 05 La La Posada Dr Drive Austin, Texas 78 7875 752 (51 (512) 34 346-2086; (51 (512) 33 338-9883 fax www.atchleycpas.com hin ingersoll ll@atchleycpas.com