M&A Shop Talk III

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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):

  • Can achieve partial equity rolled-over deferral
  • No tax election filing protocol is required to be agreed to beforehand in order to effect an asset purchase treatment
  • Less of a burden regarding tax compliance since there is no purchase price allocation filing requirement with the IRS. Please note the parties involved are still required to file certain disclosure requirements with tax return filings and keep certain permanent records.

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.

  • Eliminate pass-through taxation treatment involving a partial sale of LLC. This would typically be the case with institutional investors who are interested in the investment return without the administrative burden involving pass-through entities.

Cons compared to an asset sale election tax treatment in general:

  • No flexibility with the handling of unpaid, accrued vacation. The purchaser will be the only party that can deduct the accrued, unpaid vacation assumed
  • In the case of accrual basis target, there is no flexibility with the handling of deferred revenue tax items being deferred under Rev. Proc. 2004-34. All such deferred revenue will be completely recognized in full with no exception unlike the sale of less than 50% of LLC interest.

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 jrodriguez@aronsonllc.com or (301) 222-8220.

About Jorge Rodriguez

Jorge Rodriguez has written 26 post in this blog.

Jorge L. Rodriguez, CPA, serves as a partner in Aronson's Tax Services Group. He is a seasoned professional with more than 25 years of public accounting experience. He is known for delivering a broad, in-depth tax perspective, informed by his deep, wide-ranging industry knowledge, to every engagement for the benefit of his diverse clientele. Jorge specializes in federal tax consulting and compliance with a special focus on M&A transaction structuring, planning, and modeling. He routinely helps his clients resolve highly complex tax matters including: entity formation, classification, and conversion planning issues; accounting method and period elections and changes; consolidated tax return filling elections and tax accounting concerns; Sec 382 analysis and study; and all aspects of ASC 740 compliance involving purchase accounting and foreign operation reporting areas. Jorge works with a broad cross section of companies. His clients include emerging businesses, middle-market firms, and public business enterprises engaged in a wide variety of industries including government contracting, software development, light manufacturing, IT technology services and products sales, and specialty construction contracting. Jorge is passionate about helping his clients formulate tax strategies that make business sense. He shares his expert insights freely as a regular contributor to Aronson’s Tax Matters blog with series such as “M&A Shop Talk.” Prior to joining Aronson in 2009, Jorge was a practicing tax partner with several regional public accounting firms. He is licensed to practice in Maryland and Virginia. Professional & Community Involvement: Maryland Association of Certified Public Accountants: Member American Institute of Certified Public Accountants: Member Education: University of Maryland: Bachelor of Science in Accounting -Ongoing education in tax matters

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