Mergers & Acquisitions from a Tax Perspective
On average, small businesses across the United States pay a tax rate of 19.8%, and corporations of different sizes need to carefully account for the federal corporate tax rate of 20%.
Tax experts know the ins and outs of how various business decisions can impact organization-wide taxes across topics ranging from business expenses to the structure of mergers and acquisitions. While merging with or acquiring another company can help your organization grow to new heights, the wrong process can affect those financial benefits.
Read through this quick guide to see how organizations can make taxable or non-taxable M&As and the role you should expect tax and legal professionals to play.
Mergers & Acquisitions Can Be Taxable or Non-Taxable
There are two broad categories of M&A transactions:
- Taxable transactions
- Non-taxable reorganizations
Let's examine them in more depth.
Taxable transactions are the 'standard' type of merger or acquisition, or what occurs without due consideration and proper planning. In this type of transaction, the acquirer (or buyer) uses cash or debt to acquire substantial ownership in the seller's organization. Think of this as a relatively straightforward purchase that triggers a tax. In these circumstances, the acquirer will pay taxes on gains.
Tax-free M&A transactions are possible but require significant planning and organizational strategy. For a transaction to qualify for tax-free status, it needs to meet these four conditions mandated under Internal Revenue Code Section 368:
- Continuity of business enterprise: The acquired entity will continue to substantively operate along its previous business course
- Continuity of ownership interest: The acquirer transacted the deal with at least 50% acquirer stock as the "consideration" (essentially, the purchase price)
- Step-transaction doctrine: Qualifying M&A transactions can't be part of a larger strategy for a taxable M&A transaction
- Valid business purpose: Organizations must perform the M&A for a valid business reason, not tax avoidance
Three different types of tax-free transactions can meet these four conditions. They require either a stock-for-assets transaction or a stock-for-stock transaction. These transactions defer taxes.
How You Conduct the M&A Affects Tax Implications
The actual transaction is the primary consideration that will determine the taxable nature of an M&A deal. Acquirers can either purchase the target organization's assets or their stocks to assume ownership:
- Stock purchases: In these deal structures, the acquirer purchases—or offers consideration for—the target organization's stock. It then assumes ownership of the assets and liabilities as they are.
- Asset purchases: The acquirer purchases the operating assets of the organization but not the liabilities. These assets can include inventory, intangible assets like patents, or equipment. Acquirers can purchase only the assets they value, avoid unwanted liabilities, and (if structured correctly) defer taxes.
Mergers and acquisitions can take several years to close, especially when they are complex. Organizations should expect to receive tax notices for between two and five years after the merger begins closing out the process.
Structure Your M&A With a Tax Professional
Every merger or acquisition is different, with business parties choosing various components of an organization to own and consideration to offer. Even the state, type of business entity, and industry that the businesses operate in can factor into the final shape of the transaction and its after-effects.
Because there are so many ways to structure the deal, it's important to work with an experienced tax professional who can help ensure the tax and financial implications are the ones intended.
Involving a professional from the start will simplify the transaction, minimize the risk of tax obligations and penalties, and control the impacts on both entities. They will be able to help you understand and respond to any tax notices or other documents you receive during the process.
Navigate Mergers and Acquisition Tax Considerations with NoticeNinja
Mergers and acquisitions are excellent tools for strengthening a business and creating opportunities for continued growth. However, making missteps in the structuring or execution of the deal can lead to unwanted tax obligations.
At NoticeNinja, we know how important it is to structure M&A transactions with the proper organization and consideration. Our software solutions make tracking workflows, managing documents, and complying with tax requirements easy, which you and your tax professional can use to create a seamless process. Contact us today, or schedule a demo and see how it can help you ensure success with your next M&A deal.