Mergers and Acquisitions: 3 Tax Best Practices

A merger or acquisition may be classified as a tax-free reorganization or a taxable transaction. But there may also be state tax consequences involved depending on details of the deal. There’s a tax angle to everything. It’s always a piece of the puzzle, but it’s not the piece that you start with but rather it’s the piece that you struggle finding as you near puzzle completion. 

At this point it’s critical to have your legal team, CPA, and/or tax team on the same page and be aware that the sale of your business might have tax implications. 

Spending time reviewing tax implication, strategy, and direction provides the necessary guidelines for M&A decisions and structuring. This includes reviewing the following through the tax liability lens and evaluating the impact on the value of the merged or acquired business.

When analyzing the tax consequences of an acquisition, it is important to understand the tax classification of the business entity that owns the target business. Buyers tend to prefer the assets of a business organized in corporate form. In any M&A transaction, among the first steps is to determine how the transaction will be structured. The type of transaction—equity sale or asset sale—will determine how each party will be taxed.

Debt Implications and Tax Liabilities

Buyers of equity should check to see if the seller received financial aid through the various federal, state, and local agencies (for example, those enacted in response to COVID-19). It is integral to review all financial statements for cash injections, debt modifications, or loan restructurings made between the creditor and debtor.

Debt modifications might have provided much-needed cash flow and relief at the time, but they can trigger a taxable event and offset intended benefits.

The planning process for an equity acquisition should examine the current and projected tax liabilities of the target company, including state, local, and payroll tax issues, and how they figure into a proposed deal. 

The buyer’s footprint in new locations and/or new markets may affect state and local tax implications. Transaction agreements should address indemnification for undisclosed tax issues and provide a safety net for overlooked tax liabilities.

Best Practices

Understanding the possible debt implications and tax liabilities for a merger and/or acquisition for companies, some may ask how to navigate these steps. A few best practices for tax consideration include…

• Performing sell-side tax due diligence before the sales process begins. Buyers could walk away from a deal due to a surprise unidentified material tax issue. Not having a thorough understanding of a company’s tax position and potential areas of tax risk or benefits before conducting a sale can put sellers at a distinct disadvantage in deal negotiations. Performing sell-side tax due diligence can detect hidden problems and give the seller a bargaining chip.

• Evaluating available tax structing alternatives. Every seller wants a transition structured in a tax-efficient manner to maximize after-tax proceeds. By identifying a preferred structure at the onset of the process, sellers can proactively plan a transaction that facilitates a tax-efficient disposition. Sellers who explore tax alternatives and their implications can position themselves to negotiate a more favorable purchase price if conceding to a structure the buyer prefers.
• Negotiating tax aspects of the purchase agreement. It’s critical for sellers to have a thorough understanding of the various tax sections of a purchase agreement and proactively seek desired outcomes. A purchase agreement defines the terms and structure of a deal and which party benefits from valuable tax deductions the transaction creates. It addresses pre- and post-closing tax matters and the buyer’s right to indemnification for tax liabilities of the acquired business. 

Performing sell-side tax due diligence with the buyer in mind can remediate exposure, expedite the deal process, and define existing tax attributes. The specialized team at Jacko Law Group, PC (“JLG”) can apply these tax best practices to strengthen a seller’s bargaining position and possibly negotiate a higher sales price. Outside counsel can address tax structuring, seller due diligence, and compliance issues to achieve an optimal outcome for you and your firm. For more information or to discuss your custom M&A strategy, contact us here or at 619.278.2880.