Guiding You Through Tough Decisions to a Successful Outcome
The decision to sell or purchase a business is a complex one that requires careful assessment of many
financial, operational and other key variables. The equation becomes more complicated when a merger is being
considered. Navigating the situation successfully requires the direction and assistance of experienced
advisors who can walk you through each step of the process, carefully avoiding potential pitfalls and other
unexpected challenges inherent in the process. The result is a transaction that not only meets corporate
objectives, but also places ownership in the strongest position possible.
To help Florida business owners address these challenges, Nugent & Associates
offers both buy-side and sell-side merger and acquisition consulting services designed to help companies and individuals achieve their goals.
Many businesses will pay less federal income taxes in 2019 and beyond, thanks to the Tax
Cuts and Jobs Act (TCJA). And some will spend
their tax savings on merging with or acquiring another business. Before you jump on the M&A bandwagon,
it's important to understand how your transaction
will be taxed under current tax law.
Stock vs. Asset Purchase
From a tax perspective, a deal can be structured in two basic ways:
1. Stock (or ownership interest) purchase. A buyer can directly purchase the seller's
ownership interest if the target business
is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that's treated as
a partnership for tax purposes. This is
commonly referred to as a "stock sale," although some sales may involve partner or member units.
The now-permanent flat 21% corporate federal income tax rate under the TCJA makes buying the stock of a C
corporation somewhat more attractive for two
reasons. First, the corporation will pay less tax and, therefore, generate more after-tax income. Second,
any built-in gains from appreciated corporate
assets will be taxed at a lower rate when they're eventually sold. These considerations may justify a
higher purchase price if the deal is structured
as a stock purchase.
In theory, the TCJA's reduced individual federal tax rates may also justify higher purchase prices for
ownership interests in S corporations, partnerships
and LLCs treated as partnerships for tax purposes. Why? The passed-through income from these entities also
will be taxed at lower rates on the buyer's
personal tax returns. However, the TCJA's individual rate cuts are scheduled to expire at the end of 2025,
and they could be eliminated even earlier,
depending on future changes enacted by Congress.
2. Asset purchase. A buyer can also purchase the assets of the business. This
may be the case if the buyer cherry-picks specific
assets or product lines. And it's the only option if the target business is a sole proprietorship or a
single-member LLC (SMLLC) that's treated as
a sole proprietorship for tax purposes.
Under federal income tax rules, the existence of a sole proprietorship or an SMLLC treated as a sole
proprietorship is ignored. Rather, the seller, as
an individual taxpayer, is considered to directly own all the business assets. So, there's no ownership
interest to buy.
Important: In certain circumstances, a corporate stock purchase can be treated as an
asset purchase by making a Section 338 election.
Ask your tax advisor for details.
Business buyers and sellers typically have differing financial and tax objectives. While the TCJA doesn't
change these basic objectives, it may change
how best to achieve them.
Buyers typically prefer asset purchases. A buyer's main
objective is usually to generate sufficient cash flow
from the newly acquired business to service any acquisition-related debt and provide an acceptable return
on the investment. Therefore, buyers are
concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after the
For legal reasons, buyers usually prefer to purchase business assets rather than ownership interests. A
straight asset purchase transaction generally protects
a buyer from exposure to undisclosed, unknown and contingent liabilities.
In contrast, when an acquisition is structured as the purchase of an ownership interest, the
business-related liabilities generally transfer to the buyer
— even if they were unknown at closing.
Buyers also typically prefer asset purchases for tax reasons. That's because a buyer can step up
(increase) the tax basis of purchased assets to reflect
the purchase price.
Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or
converted into cash. It also increases depreciation
and amortization deductions for qualifying assets. Expanded first-year depreciation deductions under the
TCJA make asset purchases even more attractive,
possibly warranting higher prices if the deal is structured that way. (See "3 Favorable TCJA Changes for
Businesses" at right.)
In contrast, when corporate stock is purchased, the tax basis of the corporation's assets generally can't
be stepped up unless the transaction is treated
as an asset purchase by making a Sec. 338 election.
Important: When an ownership interest in a partnership or LLC treated as a partnership
for tax purposes is purchased, the buyer may be
able to step up the basis of his or her share of the assets. Consult your tax advisor for details.
Sellers generally prefer stock sales. On the other side of the
negotiating table, a seller has two main nontax
- Safeguarding against business-related liabilities after the sale, and
- Collecting the full amount of the sales price if the seller provides financing.
A seller may provide financing through an installment sale or an earnout provision (where a portion of
the purchase price is paid over time or paid only
if the business achieves specific financial benchmarks in the future).
Of course, the seller's other main objective is minimizing the tax hit from the sale. That can usually be
achieved by selling his or her ownership interest
in the business (corporate stock or partnership or LLC interest) as opposed to selling the business
With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any
gain on sale is generally treated as lower-taxed
long-term capital gain (assuming the ownership interest has been held for more than one year).
Important: Some, or all, of the gain from selling a partnership interest (including an
interest in an LLC treated as a partnership for
tax purposes) may be treated as higher-taxed ordinary income. Consult your tax advisor for details.
When negotiating a sale, the buyer and seller need to give and take, depending on their top priorities.
For example, a buyer may want to structure the
deal as an asset purchase. Agreeing on a higher purchase price, combined with an earnout provision, may
convince the seller to agree to an asset sale,
which comes with a higher tax bill than a stock sale.
Alternatively, a seller might insist on a stock sale that would result in lower-taxed long-term capital
gain. In exchange, the buyer might agree to pay
a lower purchase price to partially compensate for the inability to step up the basis of the corporation's
assets. And the seller might agree to indemnify
the buyer against certain specified contingent liabilities (such as underpaid corporate income taxes in
tax years that could still be audited by the
Purchase Price Allocations
Another bargaining chip in asset purchase deals — including corporate stock sales that are treated as
asset sales under a Sec. 338 election —
is how the purchase price is allocated to specific assets. The amount allocated to each asset becomes the
buyer's initial tax basis in the asset for
depreciation or amortization purposes. It also serves as the sales price for the seller's taxable gain or
loss on each asset.
In general, buyers generally want to allocate more of the purchase price to:
Assets that will generate higher-taxed ordinary income when converted into cash, such as purchased
receivables and inventory, and
Assets that can be depreciated in the first year under the expanded bonus depreciation and Sec. 179
Buyers prefer to allocate less to assets that must be amortized or depreciated over relatively long
periods (such as buildings and intangibles) and assets
that must be permanently capitalized for tax purposes (such as land).
On the flip side, sellers want to allocate more of the purchase price to assets that will generate
low-taxed long-term capital gains, such as intangibles,
buildings and land. Tax-smart negotiations can result in allocations that satisfy both sides.
Buying or selling a business may be the most important transaction of your lifetime, so it's critical to
seek professional tax advice as you negotiate
the deal. After the deal is done, it may be too late to get the best tax results.