If you’re selling your business or purchasing another business, tax implications could have a huge impact on the success or failure of your transaction. If you’re contemplating the possibility of a merger or acquisition, you should be aware of the tax implications.
Stock Sale or Asset Sale?
From a tax perspective, a transaction could be classified as an asset sale or stock sale. When it is an asset sale, the buyer is buying only those assets belonging to a company. This could happen if the buyer wants only certain products or assets. It’s the only option for a business that can be a sole-proprietorship, or an individual-member limited liability corporation (LLC) which is considered as a sole proprietorship for tax reasons.
If the targeted business is a corporation, partnership or LLC which is considered a partnership for tax purposes, the buyer may directly purchase the shares of the seller or another form or ownership stake. Whether the business that is being bought is a C corporation or a pass-through entity (that is, an S corporation, a partnership or, more generally an LLC) can make a huge difference in the taxation.
The 21% flat federal corporate income tax under the Tax Cuts and Jobs Act (TCJA), which the One Big Beautiful Bill Act (OBBBA) did not change, makes the purchase of shares of a C corporation somewhat more appealing. Why? The company will pay less tax and generate more after-tax income. Furthermore, any gains built-in from the appreciation of corporate assets are taxed at a lower rate when they’re transferred to a buyer.
The TCJA’s reduced individual federal tax rates, permanently imposed by the OBBBA can be a factor in making ownership interests in S corporations, partnerships, and LLCs more appealing than they used to be. This is due to the fact that the income that is passed-through generated by these organizations will be taxable according to the lower rates imposed by TCJA on the buyer’s personal tax returns. The buyer could also be eligible for qualified business income deduction under the TCJA and was permanently enacted through the OBBBA.
In certain situations, the purchase of stock by a corporation may be regarded as an asset purchase when you make a Section 338 election.
Buyer or Seller?
Sellers typically prefer stock sales due to tax reasons and also for nontax reasons. One of their primary goals is to reduce the tax cost of selling. This is usually done by selling ownership rights in the company (corporate stock or interest in an LLC or partnership) in contrast to selling the company’s assets.
If you sell your stock or any other ownership interest, that carries liabilities generally to the buyer. Any gains from selling are usually taxed as long-term capital gains (assuming that the ownership interest was kept for more than a year).
However, buyers typically prefer to buy assets. The primary goal is to generate sufficient cash flow from the acquired company to pay for any debts incurred in the acquisition and to earn an appropriate return from investment. So, buyers need to reduce exposure to unidentified and undisclosed liabilities and reduce taxes once the deal is closed.
A buyer may increase (step-up) their tax base of the assets purchased in order to reflect the cost of purchase. A step-up basis decreases the tax liability in the event that certain items, including inventory and receivables are sold or converted to cash. It also boosts depreciation and amortization deductions on qualifying assets.
Remember that other elements like employee benefits, could create tax problems that are not expected when merging or buying an enterprise.
How Parr & Ibarra can help
Selling the company you’ve spent years creating or becoming a new business owner through the purchase of an existing business could be the most expensive financial decision you’ll ever take. We’ll help you assess the likely tax consequences prior to discussions to prevent unpleasant tax surprises once a contract is signed. Contact us today to begin.
