Merger and acquisition (M&A) activity continues to be strong in 2021 as companies on the buy-side and sell-side take advantage of favorable market conditions and a rebounding post-pandemic economy. If M&A activity is in the cards for your business, you need to understand how recent tax developments could affect your strategy. Read on to discover tax moves and considerations that will help you make the most of your planned transaction.
1. Consider Tax Law Changes
Organizations considering M&A activity need to think about recent tax law changes. The 2017 tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA) affects certain tax provisions between now and when some of its reforms sunset at the end of 2025. These include changes to bonus depreciation benefits and the popular research and development tax credits, as well as modifications to net operating losses (NOLs) and the qualified business income deduction for owners of pass-through entities.
More past and current tax reforms that will impact your M&A decision include:
- Gross receipts taxes. These result in tax pyramiding is imposed on all inputs.
- Paycheck Protection Program (PPP) loans. State treatment on PPP loans varies based on conformity to the Internal Revenue Code.
- Taxes based on payroll or high earners. These are state or municipal taxes based on total payroll or executive compensation, with higher rates for individuals.
- Wage withholding for remote employees. Read up on legislation and litigation regarding state wage withholding requirements.
Finally, companies should consider the potential of future tax reform when structuring transactions. The Biden Administration has identified the following areas for potential changes to help pay for its legislative priorities:
- Corporate rate increase from 21% to 28%;
- Individual capital gains rate increase (retroactively) to ordinary tax rates for those with adjusted gross income over $1 million;
- International tax changes that include doubling the global intangible low-taxed income (GILTI) rate, repealing foreign-derived intangible income (FDII) deductions, and changes to base erosion and anti-abuse tax (BEAT).
The most significant considerations regarding tax law changes have to do with the timing and urgency of deals. You want to make the most of the temporary TCJA benefits while focusing on the preservation of tax attributes. A trusted tax advisor can help you make informed decisions about choice of entity if you’re afforded that kind of flexibility.
2. Adding State and Local Tax (SALT)
SALT rules add considerations to your M&A planning as well. Not all states follow federal conformity when it comes to tax reform changes, which makes some of the provisions in the TCJA more complicated.
Additionally, over 40 states have economic nexus tax provisions that can require an out-of-state seller to collect and remit sales tax once they meet a certain threshold of sales transactions or gross receipts activity within that state. The ruling in the 2018 South Dakota v. Wayfair case might affect whether you have nexus in a certain jurisdiction, so make sure you have a trusted tax advisor to guide you. A tax advisor can also help you navigate nexus-related changes for income and franchise tax, and adoption of factor presence nexus standards.
Be on the lookout for pass-through entity taxes at the state and local levels. The implementation of entity-level taxes for pass-through entities can be used to circumvent the individual SALT deduction limit. You should also be aware of trendy digital advertising taxes and expanding sales tax bases that affect the taxation of services and digital goods.
3. Don’t Forget Successor Liability
Buyers will need to be mindful of successor liability, which is the potential for a buyer to be held responsible for a tax exposure that pre-dates a transaction closing. The ultimate application of successor liability falls to state law, and you should always consult legal counsel regarding your specific situation, but in general, the type of liabilities you may encounter will depend on whether the transaction is structured as an asset acquisition or equity acquisition.
Successor Liability Risks with Asset Acquisitions
The risks associated with asset acquisitions include de facto merger and mere continuation exceptions that would affect the continuity between the predecessor taxpayer and successor taxpayer. This may also affect deemed asset acquisitions, which are equity acquisitions treated like asset purchases for income tax purposes only and therefore do not provide the same protections as legal asset purchases.
Successor Liability Risks with Equity Acquisitions
The successor liability risks associated with equity acquisitions touch all entity-level taxes, with specific exceptions for flow-through income taxes.
This liability may also affect planning for acquisitions of carve outs. Carve outs can provide greater protection when the predecessor survives and continues significant business operations. You need to consider if the acquisition is an asset carve out or a legal subsidiary carve out. You must also know about tax liabilities for consolidated C corporations.
Regardless of how your transaction is structured, some solid steps for minimizing successor liability include:
- Conduct appropriate tax due diligence.
- Know your indemnities and tax escrows.
- Don’t overlook the potential to correct historical tax filings.
- Remember to utilize bulk sale disclosures and “Certificates of No Tax Due.”
- Use “F reorganizations” to protect questionable target S elections.
- Note that tax exposure can arise in a transaction even if successor liability does not apply, such as sales or real estate transfer tax on the transaction itself.
4. Maximize Tax Efficiency When Selling
There are many ways sellers can structure transactions to make them more tax-efficient. You can elect out of installment sales, accelerating gain recognition to 2021 and locking in the current capital gain rates. Be sure to watch out for rollover equity – you might want to receive it as a taxable consideration instead.
You should also know the tax risks related to sales of C corporations and pass-through entities in order to get the most out of your deal. Other taxes to monitor include individual income taxes paid to the state of residency; the proceeds from the sale of a stock or partnership interest may be sourced to the state of domicile.
Ultimately, you’ll need to thoroughly plan for all types of taxes, including income tax on gain or proceeds from the sale, sales tax on the transaction, real estate transfer taxes, documentary stamp or recordation taxes, and more.
Your Next Steps
Be proactive when planning your tax strategy for M&A activity. Get your tax advisors involved in the process early for the best results, and remember to investigate state and local taxes. Don’t underestimate the complexity of tax law as it applies to a transaction – there are opportunities and pitfalls to be discovered.
Where Can I Learn More?
For more information on tax accounting for mergers and acquisitions, please contact us.
Kevin Eagan is a Tax Managing Director in New England. He can be reached at 617. 761.0744 or firstname.lastname@example.org.
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