Author Archives: Jorge Rodriguez

About Jorge Rodriguez

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

Jorge Rodriguez

M&A Shop Talk: Tax M&A Consultation Offering for Government Contractor Part II

buyer
Share Button

In the context of an S Corporation selling target, one of the most effective and popular tax planning techniques currently available to a buyer party seeking asset sale tax treatment optimization involves the combination of a pre-sale of F reorganization in conjunction with application of the one-day note concept into the final deal arrangement. To achieve the optimum tax results, the tax planning technique calls for the implementation of the following sequence of steps:

Step 1: Adopt a plan of reorganization and conduct a pre-sale F reorganization. This will change the current tax structuring of the S Corporation selling target to a disregarded entity status. The former S corporation selling target will now be wholly owned by the newly created S Corporation Holding Company. For more information on the benefits of consummating an F reorganization, please read the blogs, “Handling Deferred Revenue When Selling Your Business,” “M&A Tax Shop Talk – F reorganization,” and “Accrual Basis Is King When Selling Your Business.“

Step 2: Before entering the asset sales transaction, execute a plan of liquidation to be consummated by the selling shareholders within 12 months after closing. The distribution of the one-day note obligation, discussed in step 3, and the earn-out and escrow hold back components, if applicable, will not be taxable to the beneficial selling shareholders until the underlying funds are constructively received post-closing. Hence, the selling shareholders under the installment sale provision rules will step into the shoes of the liquidating S Corporation Holding Company.

Step 3: Negotiate and incorporate the one day note application concept into the final transaction arrangement. For more information of the benefits of using the one-day note application concept, please read “M&A Shop Talk: Tax Planning Using One-Day Note Concept Application.”

It is important to keep in mind that, for income tax reporting purposes, the selling shareholders do not physically need to dissolve the newly created S Corporation Holding Company, created in step 2, in order to achieve liquidation status. Additionally, the one-day note application use will never prevent the immediate taxability at closing of any built-in gains attributable to hot asset items. This includes all unrecognized cash basis deferral items, all pre-sale instalment sale deferred net profit, all advance payment received and deferred under the accrual, deferral method, and all unrecognized net profit from long-term contracts being deferred under the completed contract method.

If you are interested in scheduling an initial consultation on how to effectively structure the sale of your business, please contact Jorge Rodriguez, Aronson’s Tax Partner specializing in M&A specialized services for middle market businesses, at 301.222.8220 or email him at jrodriguez@aronsonllc.com.

Read M&A Shop Talk: Tax M&A Consultation Offering for Government Contractor Part I.

Share Button

M&A Shop Talk: Tax Planning Using One-Day Note Concept Application

One-Day Note
Share Button

An S Corporation selling shareholder should always evaluate whether the “one-day note” obligation planning concept will achieve federal and state tax optimization objectives of an asset sale transaction arrangement. There are some exceptions to applying this concept due to business reasons or overriding tax regimes, beyond the scope of this blog.

The current tax provisions of the one-day note tax calculation require that the pre-liquidation calculated tax basis of an S Corporation selling target, following the consummation of an asset sale transaction, should be allocated between the cash and non-cash liquidation components respectively. Accordingly, the selling shareholders will immediately recognize the cash liquidation proceeds less allocated S Corporation tax basis. Any remaining tax basis allocated to the deferred income items will be recognized proportionally as the deferred income items are collected.

The described mandatory allocation mechanism will generally create an acceleration of gain recognition tax effect. This is because a substantial portion of the pre-liquidating stock tax basis calculated, including the gain recognition from the deemed asset sale prior to liquidation, will be allocated to the deferred income item. Such allocated stock basis will not be recognized until the deferred income items are eventually collected. In extreme situations, the non-collection of deferred income items can create an unused capital loss whipsaw tax effect that is beyond the scope of this blog. Therefore, the proper application of the one-day note planning concept will mechanically reduce the pre-liquidation tax basis allocated to the deferred income items and safeguard against the described negative tax implications.

From a state tax minimization perspective, many state taxing jurisdictions currently conform to federal law income tax statutes regarding installment sale reporting rules. This includes the non-taxable treatment and distribution of a deferred note receivable obligation stemming from an asset sale or liquidation scenario. The one-day note planning concept will generally minimize, or in some case totally mitigate, all non-resident income tax burdens incurred by a bona fide residents and selling shareholders living in a  no state tax jurisdiction, such as Florida, Texas, and Washington. This concept would also be applicable to certain selling shareholders who would be subject to double taxation because of non-conformity S Corporation pass-through tax treatment, such as the District of Columbia with respect to Virginia residents. This is because the District of Columbia franchise tax is not considered a creditable income tax under Virginia income tax statute.

Please note that the one-day note tax planning concept will only mechanically work pursuant to an approved and adopted plan of liquidation that is beyond the scope of this blog or pursuant to a Sec 338(h) (10) or Sec 336(e) tax election.

If you are interested in scheduling an initial consultation on how to effectively structure the sale of your business, please contact Jorge Rodriguez, Aronson’s Tax Partner specializing in M&A specialized services for middle market businesses, at 301.222.8220 or email him at jrodriguez@aronsonllc.com.

Share Button

M&A Shop Talk: Tax M&A Consultation Offering for Government Contractor Part I

buyer
Share Button

Aronson has noticed that the current negotiation trend for large public companies and/or private equity strategic buyers, those who generally make-up the majority of the buyer pool for government contractors seeking exiting, is to not compensate the selling party for the incremental tax to be incurred upon transacting an asset sale form transaction versus straight stock sale.

The buyer party representatives controlling the negotiation will generally assert that the incremental tax burden to be incurred by the selling party for agreeing to an asset sale tax reporting treatment has already been considered in arriving at the selling price offering. Accordingly, it is vital for the selling party before commencing the negotiation phase to independently quantify the true incremental tax on an asset sale scenario, which could be more complicated than simply looking at the deferred taxes from the use of permissible tax accounting method.

For example, if your business that is taxed as a flow-through entity that is not subject to entity level taxation for federal and conforming states happens to be headquartered in Virginia, but a substantial amount of business is conducted within Washington, DC; you potentially on an asset sale tax election transaction have material incremental tax exposure from the gain that will be subject to double taxation of approximately 10%. Why?  Because of the Washington, DC entity level imposed franchise tax of 9.975%, with no offsetting credit in your resident state of Virginia. Another example would be if one of the selling shareholders happens to be a bona fide resident of a state with no income taxes such as Florida, Texas, Washington State, etc., in such instance, there is clearly an incremental tax burden to be incurred by that particular selling shareholder on an asset sale involving a flow-through selling entity.

There is a sequence of tax planning techniques that could be incorporated into the final deal to mitigate and/or lessen the whipsaw effects from the described incremental tax scenarios. If you are interested in discussing how to effectively structure the sale of your business, please contact Jorge Rodriguez at 301.222.8220 or email me at jrodriguez@aronsonllc.com.

Read M&A Shop Talk: Tax M&A Consultation Offering for Government Contractor Part II.

Share Button

M&A Shop Talk IX

M&A
Share Button

This blog is a continuation of a three part series, the first blog can be found here. As previously discussed, when negotiating the best selling price for your business, tax attributes like NOLs and R&D credits play an important factor during negotiations. Such attributes allow the seller to economically accommodate the buyer with an asset acquisition transaction, which if properly structured would prevent the transaction proceeds from being doubly taxed.

The general rule of thumb in a negotiation process works so that the inherit tax benefits the buyer party receives will at minimum approximate the present value of the 15 years amortization deduction attributable to purchased intangibles. Therefore, it is imperative as the seller that before the letter of intent and/or exclusivity letter is executed, you reach an agreed to percentage of the described minimum tax benefit with the buyer. Moreover, at minimum you want the buyer party to make you whole in case there are not enough tax attributes carried over at the target entity level to offset the anticipated asset sale gain, and thus prevent the double taxation ramifications.

In the context of a typical exiting scenario involving a stand-alone “Target entity”, that is C corporation structured with large NOLs and R&D credits carried over, there are two basic tax structuring approaches to evaluate that could conceivably yield similar tax results that would appear more favorable toward the seller.

The first approach if there are no contract novation constraints, is to consummate a straight asset sale transaction followed by a liquidation of the target entity. Accordingly, an analysis calculation must be conducted beforehand to make a determination of whether the estimated calculated gain from the asset sale structured transaction will be entirely offset with the target entity’s carried over tax attributes. If following this route, make sure to take into consideration transaction bonuses, etc. Now, the net liquidation proceeds from the asset sale would be accordingly taxable to the investor’s selling group and taxed at the preferential federal long-term capital gain rate of 20% and state domiciliary rate, if applicable. From a pure liability assumption protection perspective, this approach would be the most beneficial to the buyer party.

The second approach to consider would entail completing a qualified stock sale to make an IRC Section 338 election under IRC Section 338(g) tax regime hereafter referred to as “regular Section 338 election”, to treat such qualified stock sale as a deemed asset sale at the target entity level for tax reporting purposes. Accordingly, from a pure contract novation perspective, it would be the most attractive legal structure to the buyer party. However, from a liability assumption risk management perspective, the buyer party assumes all inherit liabilities of the target entity including unknown contingencies that would require seller party indemnification (i.e., generally 10% to 15% of the base price will be held back in escrow and subject to indemnification terms and conditions). Please note to effect a regular Section 338 election, at least 80% of the underlying stock ownership must be sold within a certain 12-month period and certain legal and administrative requirements must be agreed and complied thereto by the seller and buyer parties.

Now, under a IRC Section 338(g) tax election, tax regime, the selling shareholders irrespective of the asset gain recognition transaction as described above are required to report the stock sale. Lastly, all the tax attributes of the target entity can only be utilized by the selling target entity with the filing of its final return.

Next time on M&A Shop Talk we’ll work through an example illustrating the utilization of tax attributes under IRC Sections 382 through 384 limitation provisions as discussed in the initial blog. We’ll incorporate a summary analysis of both described structuring alternatives, including the pros and cons for selecting each. In the meantime, if you have any questions or need additional information, please feel free to call me at 301-222-8220 or email me at jrodriguez@aronsonllc.com.

 

 

Share Button

M&A Shop Talk VIII

M&A
Share Button

This week commences a three-part series specifically tailored to businesses with valuable self-created intellectual property appreciation looking for an exit strategy.

It’s no secret that most businesses with large self-created intangibles and intellectual property burn thru a lot of capital, and may have gone through several rounds of capital infusion. This creates a unique tax profile, which requires proper structuring and care to maximize the after-tax net proceeds to the selling shareholders participating in a liquidity event.

The first step before jumping into the ideal tax structure is analyzing and estimating how many tax attributes (i.e., NOLs, R&D credits, etc.) the target entity has available for utilization. This crucial pre-sale housekeeping matter is often overlooked and pushed to the back-end of the sales process, which can be costly. It is illegal under US tax code IRC Section 269 to sell tax attributes per se. However, it is business prudent to know before beginning price negotiations how many tax attributes are available; as the buyer party may want to negotiate an asset sale in order to deduct the purchase price attributable to depreciable tangible property over the prescribed useful life, and amortizable intangibles for tax purposes over 15 years.

Accordingly, the first order of tax planning is to seek the advice of a qualified tax professional with experience navigating IRC Sections 382 through Section 384. These current tax provisions restrict and in some cases permanently limit the future utilization of NOLs and general business credits from being carried forward by the selling entity when there is a change of control greater than 50% of the underlying ownership interest within any running three-year period. The aggregate change of control noted in Section 382 within the three-year running period is calculated using the full value methodology or hold constant principles.

The base limitation is the estimated enterprise fair market value pre-change of ownership times the highest published adjusted long-term tax rate under IRC Section 382, covering the month of the change or the prior two months. The calculated base limitation is pro-rated for the year of change based on number of days left within the year, unless a specific closing of the books election is made by the affected taxpayer. The base limitation could be further increased by the recognition of built-in gains measured at the date of ownership change and recognized subsequent to such change.

Now, following the guidance of IRS pronouncement pursuant to IRS Notice 2003-65 and electing the “Section 338 approach”, the affected seller can increase the aforementioned base limitation for the first five taxable years subsequent to the Section 382 change date (i.e. a taxable years equal 365 days). The described enhancement provision allows the electing taxpayer to account only for purposes of the overall Section 382 limitation calculation, the calculated, hypothetical depreciation and amortization expense attributable to unrecognized built-in gains measured at the date of Section 382 change as a deemed recognized built-in gains. For example, assume the change date is effective July 1 of  Year 1, and the unrecognized built-in gains attributable to Section 197 intangibles measured at July 1, using pre-change fair market value under a hypothetical Section 338 calculation format is $15M. The hypothetical calculated amortization expense allowed to be accounted as deemed recognized built-in gains under the described Section 338 approach election would be approximately $500,000 for Year 1 and Year 6. Which is approximately 50% of prorated amortization for each year based on 365 days equal to one taxable period and $1M for Years 2 through 5, or the full year amortization.

Next week, we’ll cover tax planning concepts that work well for those interested in the aforementioned concept and an example transaction scenario covering the key points. In the meantime, if you have questions or want to discuss your individual organization, please feel free to call me at 301.222.8220 or email me at jrodriguez@aronsonllc.com.

Share Button

View Archives

Blog Authors

Latest Webinar Videos