When businesses engage in the acquisition of another entity, the tax implications of such a deal are a crucial element that must be accounted for. Those implications look different depending on whether the deal is a stock sale or an asset sale.
Each of these deals serves a different purpose in the business landscape. Working with an experienced firm that understands both tax and business law is an invaluable asset in the acquisition process.
Tax Considerations in an Asset Deal
An asset purchase takes place when a buyer purchases some or all of the assets owned by a company but not the company itself. In an asset purchase, the buyer can use the tax basis of the acquired assets, including goodwill, as the purchase price. This adjustment allows tax deductions for the amortization of those assets over the useful lives of the assets, offering tax efficiency.
However, it’s essential to note that tangible assets, such as inventory, will likely trigger a tax to the purchaser. Additionally, some states levy a general intangibles tax on transfers.
For the seller, depreciation recapture comes into play when an asset is sold at a price higher than its tax basis as adjusted by previously claimed depreciation. For example, if you purchased an asset for your business at $200,000 two years ago and claimed $150,000 in depreciation immediately, you are left with a tax basis of $50,000. If the asset is sold in a deal that values that same asset at $120,000, you are left with a $70,000 gap between the tax basis and the sale price that must be accounted for.
Tax Considerations in a Stock Deal
A stock purchase is a complete purchase of a company, including all the assets and liabilities. Stock purchases thus have different tax outcomes. The selling shareholders experience capital gain or loss based on the difference between the basis of the stock (not the assets) and the sale price. Long-term capital gains on stocks held for the minimum period (one year) are taxed at a lower rate than ordinary income. This distinction is key for achieving the utmost tax efficiency in a stock sale or purchase.
A notable strategy in stock purchases, especially for S corporations, is treating the acquisition as an asset purchase for federal income tax purposes. This election, under Section 338(h)(10) of the Internal Revenue Code, allows the transaction to be treated as a stock purchase for corporate law purposes while benefiting from asset sale tax treatment for federal taxes. This usually allows a buyer to achieve benefits from the amortization, as mentioned above, barring specific “look through” provisions in some states or foreign territories.
Sellers generally find the tax outcomes favorable in stock deals, as these transactions typically result in capital gains or losses. With capital gains currently taxed more favorably than ordinary income, this route is often advantageous. However, buyers do not prefer stock sales because as they are purchasing the company, they are also purchasing all of the liabilities of the company (just as all of the assets). This could be beneficial though, because the contracts of the company being purchased, as well as licenses and permits, may be transferred to the buyer in the stock sale as well.
Benefits Under the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) of 2017 significantly impacted tax strategies in asset purchases. It reduced the top corporate tax rate from 35% to 21%, making corporate-level tax in asset purchases more favorable. Additionally, the TCJA expanded the bonus depreciation rules, increasing the range of transactions that can be structured tax-efficiently as asset purchases.
State-Specific Considerations
It’s also important to consider state-specific taxes. For instance, California imposes a 2.5% gain at the entity level for S corporations. Such nuances can influence the decision to make a 338(h)(10) election, especially in scenarios where the sale might result in a corporate-level loss.
Negotiating Transaction Taxes
A critical aspect of acquisition negotiations is deciding who holds the responsibility for various taxes associated with the deal (sales, intangibles, real estate transfer, or stamp tax). While one party is legally required to pay the tax, either party is able to negotiate additional payments or concessions to offset the tax burden.Understanding the tax implications of business acquisitions is complex but critical. Whether it’s an asset or stock purchase, each approach has distinct tax consequences that can significantly affect the overall financial outcome. Contact the team at Dahl Law Group for a firm that has a wealth of experience navigating these complex deals and ensuring that clients are able to make informed, tax-efficient decisions in business acquisitions.
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