Have you heard of a horizontal, double dummy technique to achieve a partial asset sale tax treatment with stepped-up basis adjustment? A method that also accommodates a tax-deferred equity rolled-over feature?
Generally, this tax planning technique is more common in the context of a public company business combination scenario; however, it has some limited applicability in private M&A transaction planning considerations. The transaction arrangement uses a combination of tax-free reorganization doctrine provisions under IRC Section 368, along with incorporation tax rules pursuant to IRC Section 351 involving multiple entities to achieve the acquisition of a target entity with stepped up-basis tax treatment to the buyer party.
To keep things simple, if the overall transaction arrangement is properly structured and meets certain statutory provisions including valid business purposes, ownership control absolute minimum rule requirements, and continuity of interest test that are beyond the scope of this blog; the stock equity rolled-over component (i.e. received under the Section 351 incorporation exchange) is generally tax deferred. The cash consideration portion received (i.e. referred to as boot) is fully taxable. The character of the taxable boot is calculated based on the purchase price allocation. Thus the portion of the taxable boot consideration allocated to hot assets (i.e., unrecognized cash basis items including appreciated, non-long-term capital gain assets) are generally taxed as ordinary income. Liabilities assumed as part of the overall deal arrangement are generally not taxable, provided it does not exceed the aggregate tax basis of the underlying assets being transferred. Accrued, unpaid liabilities assumed and not previously deducted for tax purposes are generally not included in the excess tax calculation.
Now, as a general rule of thumb with some intricacies not mentioned in this blog, the major pros and cons from a tax benefit perspective in the context of private M&A deals are as follows:
Pros over asset purchase election tax treatment under Section 338(h)(10) or Section 336(e):
Pros over sale of partial LLC interest including conversion of target to an LLC pursuant to an F reorganization, which involve an S corporation target as described in this previously written blog from April 4, 2016.
Cons compared to an asset sale election tax treatment in general:
Stay tuned for the next M&A shop talk. We’ll discuss the handling of deferred revenue items involving asset sale transaction arrangement. In the meantime, please feel free to schedule a consultation with Jorge Rodriguez, CPA. Jorge is a Tax Director and part of Aronson’s Financial Advisory Services Group. Jorge can be reached by email at firstname.lastname@example.org or (301) 222-8220.