Over the past few months, we’ve discussed selling your closely held business. We’ve discussed quite a few topics, but almost entirely from the seller’s vantage point.
This week, we are looking at a few of the potential tax considerations of such a transaction – from the buyer’s view.
Tax considerations play a part in every step of a sale/purchase process and should be seriously evaluated before a letter of intent is drafted.
Indeed, tax consequences can determine whether the buyer and seller agree to structure the transaction as an asset sale or a stock sale. Both can have tax advantages and disadvantages:
Tax Considerations in an Asset Sale:
- The buyer of the assets will generally forego the business’ cash on hand but will also forego the business’ liabilities. In some cases, the seller must repay all business debt before the sale’s closing; in others, covenants, warranties, indemnifications, and representations in the purchase agreement will need to be drafted explicitly indemnifying the buyer and the seller with respect to previously-undertaken business debt and obligations.
- In an asset acquisition, the buyer may receive a step-up basis for the amount of the purchase price allocated to purchased assets, provided the amount allocated to those assets is greater than the tax basis of the depreciated asset. The buyer thereafter can take depreciation over the tax life of the assets based upon the amount allocated at purchase.
- However, in some cases, the tax benefits offered by an asset sale may not be considered to fully offset difficulties pertaining to transfers of contracts and leases, intellectual property concerns, and permitting logistics. Each transaction will need to have its own structure based on the individual transaction.
Tax Considerations in a Stock Sale:
- In a stock sale, the buyer will purchase the business’s stock from the selling shareholders (subject to such limitations as s/he may agree to with the seller regarding corporate debt, potential future liabilities, etc.).
- However, the buyer in a C-Corporation stock sale also assumes any prior-year net operating losses (NOLs). Before the Tax Cuts and Jobs Act (TCJA), signed into law on December 22, 2017, NOLs could be carried back for 2 years and carried forward for 20 years. The TCJA eliminated NOL carrybacks, allowed indefinite carryforwards, and limited the deduction to 80% of the NOL. However, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law on March 27, 2020, provides that NOLs from 2018, 2019, and 2020 can be carried back for 5 years at 100% deductibility or forward indefinitely at 80% deductibility, beginning with tax year 2021.
Other Potential Tax Considerations:
- COVID-19-related legislation provided employers with a number of avenues of financial relief to retain staff at full pay and maintained hours. These included both rounds of Paycheck Protection Program (PPP) loans and the Employee Retention Credit (ERC). If the business being acquired has unforgiven PPP loans or other unresolved funding matters related to COVID-19 relief, check your obligations and opportunities carefully. You may be able to apply for forgiveness of a PPP loan yourself, but be sure to follow the procedures outlined in the SBA’s procedural notice Paycheck Protection Program Loans and Changes of Ownership, effective October 2, 2020.
- State and local taxes: if you purchase a business in a state different from the one(s) you are already operating in, you will likely incur income tax liabilities. Know what you are getting into, and be prepared.
The above are only a few highlights among the many tax considerations to consider when buying a going business. Consult with the tax attorney, financial advisor and others among your Transaction Advisory Team for a complete picture.
If you are considering the potential acquisition of an existing business, I strongly recommend that you consult with us before making any major decisions – and the sooner, the better, as the process of purchasing a closely-held business can take six months to a year, and sometimes longer.
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Until next time –