Making Smart Mergers and Acquisitions Under Today’s Tax Law
Many businesses will pay less federal income taxes in 2018 and beyond, thanks to the Tax Cuts and Jobs Act (TCJA). And some will spend their tax savings on merging with or acquiring another business. Before you jump on the M&A bandwagon, it's important to understand how your transaction will be taxed under current tax law.
3 Favorable TCJA Changes for Businesses
The Tax Cuts and Jobs Act (TCJA) contains several provisions that will lower federal income taxes for businesses. Here’s an overview of three pro-business changes.
Stock vs. Asset Purchase
From a tax perspective, a deal can be structured in two basic ways:
Business buyers and sellers typically have differing financial and tax objectives. While the TCJA doesn’t change these basic objectives, it may change how best to achieve them.
When negotiating a sale, the buyer and seller need to give and take, depending on their top priorities. For example, a buyer may want to structure the deal as an asset purchase. Agreeing on a higher purchase price, combined with an earnout provision, may convince the seller to agree to an asset sale, which comes with a higher tax bill than a stock sale.
Alternatively, a seller might insist on a stock sale that would result in lower-taxed long-term capital gain. In exchange, the buyer might agree to pay a lower purchase price to partially compensate for the inability to step up the basis of the corporation’s assets. And the seller might agree to indemnify the buyer against certain specified contingent liabilities (such as underpaid corporate income taxes in tax years that could still be audited by the IRS).
Purchase Price Allocations
Another bargaining chip in asset purchase deals — including corporate stock sales that are treated as asset sales under a Sec. 338 election — is how the purchase price is allocated to specific assets. The amount allocated to each asset becomes the buyer’s initial tax basis in the asset for depreciation or amortization purposes. It also serves as the sales price for the seller’s taxable gain or loss on each asset.
In general, buyers generally want to allocate more of the purchase price to:
- Assets that will generate higher-taxed ordinary income when converted into cash, such as purchased receivables and inventory, and
- Assets that can be depreciated in the first year under the expanded bonus depreciation and Sec. 179 deduction breaks.
- Buyers prefer to allocate less to assets that must be amortized or depreciated over relatively long periods (such as buildings and intangibles) and assets that must be permanently capitalized for tax purposes (such as land).
On the flip side, sellers want to allocate more of the purchase price to assets that will generate low-taxed long-term capital gains, such as intangibles, buildings and land. Tax-smart negotiations can result in allocations that satisfy both sides.
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.