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Making Smart Mergers and Acquisitions under Today's Tax Law

This article appeared in the May 2019 issue of MiMfg Magazine. Read the full issue and find past issues online.

Yeo & Yeo’s 2019 LEA National Manufacturing Outlook Survey identified that more manufacturers are considering mergers and acquisitions (M&A) this year to keep their companies on track for growth. Twenty-one percent expect to acquire another business in 2019 and 16 percent are in the pre-planning stage of a merger or acquisition. Before you jump on the M&A bandwagon, it’s important to understand how your transaction will be taxed under current tax law.

Stock vs. Asset Purchase

From a tax perspective, a deal can be structured in two ways:

1. Stock (or ownership interest) purchase. A buyer can directly purchase the seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC.) This is called a “stock sale.”

The flat 21 percent corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) makes buying the stock of a C corporation somewhat more attractive because:

  • The corporation will pay less tax and generate more after-tax income, and
  • Any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.

These considerations may justify a higher purchase price if the deal is structured as a stock purchase.

Reduced individual federal tax rates as a result of TCJA may also justify higher purchase prices for ownership interests in pass-through entities because the income from these entities will be taxed at lower rates on the buyer’s personal tax returns.

2. Asset purchase. A buyer can purchase the assets of the business, which is the only option if the target business is a sole proprietorship or single-member LLC (SMLLC) treated as a sole proprietorship for tax purposes.

Important: In certain circumstances, a corporate stock purchase can be treated as an asset purchase by making a Section 338 election.

How does the TCJA Affect Buyers and Sellers?

While the TCJA doesn’t change the buyer’s or seller’s objectives, it may change how they achieve them.

Buyers typically prefer asset purchases

For legal and tax reasons, buyers usually prefer to purchase business assets rather than ownership interests. A straight asset purchase transaction generally protects a buyer from exposure to undisclosed, unknown and contingent liabilities. Expanded first-year depreciation deductions under the TCJA make asset purchases even more attractive, possibly warranting higher prices if the deal is structured that way.

In contrast, when corporate stock is purchased, the tax basis of the corporation’s assets generally can’t be stepped up.

Sellers generally prefer stock sales.

Sellers want to minimize the tax hit from the sale, which can usually be achieved by selling ownership interest in the business (corporate stock or partnership or LLC interest) as opposed to selling the business assets.

Sellers have two main nontax objectives:

  • Safeguarding against business-related liabilities after the sale, and
  • Collecting the full amount of the sales price if the seller provides financing.
The Bottom Line

Buying or selling a business may be the most important transaction of your lifetime, so it’s critical to seek professional tax advice as you negotiate the deal. After the deal is done, it may be too late to get the best tax results.

About the Authors

Amy BubenAmy Buben, CPA, CFE is a senior manager with Yeo & Yeo CPAs & Business Consultants. She may be reached at 989-793-9830 or amybub@yeoandyeo.com.

This article appeared in the May 2019 issue of MiMfg Magazine. Read the full issue and find past issues online.

Yeo & Yeo’s 2019 LEA National Manufacturing Outlook Survey identified that more manufacturers are considering mergers and acquisitions (M&A) this year to keep their companies on track for growth. Twenty-one percent expect to acquire another business in 2019 and 16 percent are in the pre-planning stage of a merger or acquisition. Before you jump on the M&A bandwagon, it’s important to understand how your transaction will be taxed under current tax law.

Stock vs. Asset Purchase

From a tax perspective, a deal can be structured in two ways:

1. Stock (or ownership interest) purchase. A buyer can directly purchase the seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC.) This is called a “stock sale.”

The flat 21 percent corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) makes buying the stock of a C corporation somewhat more attractive because:

  • The corporation will pay less tax and generate more after-tax income, and
  • Any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.

These considerations may justify a higher purchase price if the deal is structured as a stock purchase.

Reduced individual federal tax rates as a result of TCJA may also justify higher purchase prices for ownership interests in pass-through entities because the income from these entities will be taxed at lower rates on the buyer’s personal tax returns.

2. Asset purchase. A buyer can purchase the assets of the business, which is the only option if the target business is a sole proprietorship or single-member LLC (SMLLC) treated as a sole proprietorship for tax purposes.

Important: In certain circumstances, a corporate stock purchase can be treated as an asset purchase by making a Section 338 election.

How does the TCJA Affect Buyers and Sellers?

While the TCJA doesn’t change the buyer’s or seller’s objectives, it may change how they achieve them.

Buyers typically prefer asset purchases

For legal and tax reasons, buyers usually prefer to purchase business assets rather than ownership interests. A straight asset purchase transaction generally protects a buyer from exposure to undisclosed, unknown and contingent liabilities. Expanded first-year depreciation deductions under the TCJA make asset purchases even more attractive, possibly warranting higher prices if the deal is structured that way.

In contrast, when corporate stock is purchased, the tax basis of the corporation’s assets generally can’t be stepped up.

Sellers generally prefer stock sales.

Sellers want to minimize the tax hit from the sale, which can usually be achieved by selling ownership interest in the business (corporate stock or partnership or LLC interest) as opposed to selling the business assets.

Sellers have two main nontax objectives:

  • Safeguarding against business-related liabilities after the sale, and
  • Collecting the full amount of the sales price if the seller provides financing.
The Bottom Line

Buying or selling a business may be the most important transaction of your lifetime, so it’s critical to seek professional tax advice as you negotiate the deal. After the deal is done, it may be too late to get the best tax results.

About the Authors

Amy BubenAmy Buben, CPA, CFE is a senior manager with Yeo & Yeo CPAs & Business Consultants. She may be reached at 989-793-9830 or amybub@yeoandyeo.com.
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