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Structuring the Deal: Tax Implications in Corporate Acquisitions

Myriad decisions in the acquisition process will have tax implications for the entities on both sides of the transaction. One of those decisions is which basic deal structure to use—an asset purchase or a stock purchase. In an asset purchase, all or nearly all of the assets and liabilities of the target are transferred. In a stock purchase or equity purchase, the corporate stock or partnership interests are transferred. This blog post will address general tax consequences of either basic deal structure when the entities involved are corporations.

From a tax perspective, sellers generally prefer stock deals and buyers generally prefer asset deals. In an asset deal, the sale for a single stated purchase price is actually treated as a set of separate transfers of each asset being acquired and each liability assumed. To determine taxes on the assets, the purchase price is allocated among the assets in accordance with their respective fair market values. The seller’s gains are calculated by taking the difference between the payment prices and the adjusted basis of the property being transferred. Each gain will be characterized separately based on different properties sold. In a whole-business sale with liquidation of the corporation following the asset sale, gains are taxed at two levels—the corporate and the shareholder level, making stock sales generally more attractive to sellers.

On the buy side, the various assets are acquired on a step-up basis, meaning the asset bases are set at fair market value. The buyer recognizes the assets with the full step-up basis and new holding periods. This often creates a beneficial tax consequence for the buyer, allowing the buyer to reap the benefits of depreciation deductions where applicable, reducing taxes. Asset deals also allow the buyer to pick and choose which assets to acquire, and to avoid assuming all of the target’s liabilities, especially future costs of uncertain amount from issues such as Stark Law violations in the health care sector.

In a stock purchase deal, the seller shareholders recognize a gain represented by the difference between the purchase price received and their bases in the target’s stock. On the buy side, the acquiring company acquires the stock of the target company with a tax basis equal to the cash paid and liabilities assumed. The individual assets retain their character, bases, and holding periods, which is the key difference between a stock purchase and asset purchase for tax purposes. The acquirer benefits from this when, for example, the target has net operating losses that the acquirer may use against its other income.

The choice between basic deal structures is not always a zero-sum game though. Many scenarios create an opportunity for a net economic benefit. For example, the acquiring company may have more net operating losses than it can use and therefore have no need for depreciation deductions. Structuring the deal as a stock purchase could minimize the seller’s tax liability without negatively affecting the buyer.

Sometimes a deal might even take the form of a stock transfer but be treated as an asset sale for tax purposes if the transacting parties make an IRS Section 338(h)(10) election. Because there are often multiple ways to structure a deal to achieve the parties’ business goals, consulting an experienced attorney for advice early in the negotiation process can yield substantial economic benefits.

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