Tax considerations in the M&A game

Thinking of buying or selling a business? Make sure you consider the tax issues. Prior to looking at buying or selling a business, land care professionals should consult with a competent mergers and acquisitions attorney and/or a CPA who is well-versed in the tax aspects of business purchase and sales.
 

Compliance issues

With respect to compliance, many states require compliance with bulk sale rules. Bulk sale rules are intended to protect creditors of the seller as well as state departments of taxation by giving them notice of a bulk sale. The object of the bulk sale rules is to make sure the seller doesn’t sell the business and disappear with the proceeds without paying creditors or any unpaid taxes due. By having the purchaser report the bulk sale, the state has the ability to set up an escrow out of proceeds of the transaction to cover any liabilities.

Non-compliance with bulk sales filings by the purchaser can result in the purchaser becoming responsible for such liabilities if they exist.

Most states have exemptions to sales tax on assets purchased pursuant to a bulk sale. However, there are a number of states that require sales tax to be paid on motor vehicles purchased pursuant to a bulk sale. You need to check with your state to make sure you are in compliance and/or pay the sales tax if any is due. When structuring a deal as an asset purchase (see below as most in our industry are structured this way), IRS Form 8594 must be completed and attached to the tax return of both the buyer and seller.

This form provides the IRS with details of how assets were divided among different classes for purposes of depreciation and amortization, as well as ordinary versus capital gain treatment. In order for the IRS to verify that the purchase price allocation was made consistently for both buyer and seller, the form is to be filed by both and they should reflect the same allocations.
 

Tax minimization

The overarching theme when it comes to minimizing taxes relates to capital gains versus ordinary income. Capital gains are taxed at a lower rate (minimum 0 percent, maximum 20 percent, plus net investment income tax of 3.8 percent). Capital gains apply to sales of capital assets that are held longer than one year.

Ordinary income can be taxed as high as 39.6 percent. While it’s easy to see why a seller would want a capital gain, a buyer would want deductions related to the sale at ordinary rates to reduce as much ordinary income for monies expended as part and parcel of the purchase. This is where proper planning and negotiation between buyer and seller become important in reducing the tax burden of the seller while giving the buyer the maximum amount of tax benefit.
 

Asset sale versus stock sale

In purchases and sales of companies, there are two main methods of structuring a deal. Depending on the objectives of the buyer and seller, and after considering tax and legal alternatives, the parties will agree to either an asset deal or a stock deal. In our industry, most deals are asset deals as they reduce legal liability to the purchaser and allow tax benefits to be shared by both buyer and seller.

In an asset sale, the assets of the company are sold to the buyer (as opposed to the stock of ownership). Included in the typical assets purchased category are trucks, cars, equipment, inventory, supplies, computers, furniture, fixtures, customer lists, Internet domain names, as well as phone and fax numbers. While all these items get sold to the buyer, the seller is left with the corporation or LLC, which she can either continue to operate or dissolve once the deal is completed.

In a stock deal, the seller sells the stock or ownership in the corporation or LLC and passes the entire entity to the buyer.
 

Tax benefits in an asset deal

The tax benefits in an asset deal can be split between buyer and seller as agreed, as the seller is interested in all gains being long-term capital gains and the buyer is interested in deducting as much of the purchase price as quick as possible at ordinary rates.

This can be done by allocating a large portion of the purchase price to assets that can be depreciated quickly as well as creating employment or consulting agreements with the seller that result in ordinary deductions to the buyer.
 

Tax benefits in a stock deal

The tax benefits in a stock deal are mainly for the seller as the seller receives capital gains treatment as if he sold his stock in the stock market. The buyer must capitalize the purchase price as part of his cost basis for the shares acquired and can be used to reduce the gain when he resells the shares. Because there is very little tax benefit the buyer can derive from this type of sale, it usually takes more cash outlay for the buyer to do this type of transaction.
 

Installment sales

For those deals that include a payout over time, the buyer can deduct interest payments on any notes payable to the seller over the payout period and the seller can recognize capital gain over the payout period instead of recognizing the whole gain the date the deal is signed.

This provides benefit to both buyer and seller when a cash deal isn’t feasible or desired. In addition, the seller defers his gain by recognizing a small portion of gain during each year of the payout. There is a good possibility that the seller will be in a lower tax bracket in those subsequent years. He likely will only recognize a small portion of the gain in those years, instead of recognizing the entire gain all in one year and driving up his income into the highest tax bracket in the year of sale.
 

S Corp versus C Corp

As a seller, it’s important to understand the corporate structure of your entity. If you are a C corp, you are at a distinct disadvantage to that of an S corp or LLC taxed as a partnership when doing an asset deal. This is because you may be subject to double taxation on the sale of the assets: once at the corporate level and once as you liquidate the corporation.

With an S corporation you are taxed only once as the tax on the gains hold their character (capital or ordinary) and are only paid at the individual shareholder level. There are ways to mitigate this by having your C Corp make an S election and waiting several years so that the built-in gains rules don’t bite. Another way to mitigate is by selling personal goodwill. Both of these are advanced topics and you should speak to a qualified CPA or tax attorney in order to consider your options.
 

Conclusion

When looking to buy or sell a business, it’s really not the price you receive as the seller or the price you pay as the purchaser that is as important as the amount you keep or the amount you pay after tax benefits. If you are in the M&A game and you have identified a potential deal, it is always advisable to consult with your tax advisers early.

The author is a CPA in New Jersey and owns an accounting firm that caters to landscape professionals throughout the United States.