This article summarizes some of the tax benefits—and the tax complexities—associated with a taxable stock purchase acquisition structure. For illustrative purposes, the author analyzes a hypothetical involving the acquisition of a C corporation by an LLC.
Multiple factors are contributing to the trend away from asset acquisitions. Legal counsel for corporate acquirers is now more comfortable in drafting contractual representations and warranties to cover any adverse effect related to the acquirer assuming unknown liabilities.
Further, the common availability of “reps and warranties” insurance related to most merger and acquisition transactions is contributing to the rise in the use of the deal structure.
Most acquisitions of larger companies are structured as nontaxable stock acquisitions. It is possible to structure a stock acquisition as a taxable stock purchase transaction. However, there are numerous tax complexities related to this taxable stock acquisition deal structure.
A taxable stock acquisition transaction is a potentially attractive structure in order for the target company seller to pay one level of tax on the company sale—and to potentially pay no tax if Section 202 applies.
For corporate acquirers, the taxable stock acquisition structure will likely result in the easy transfer of the target company’s (1) business contracts and agreements and (2) registrations and licenses.
This intangible asset transfer result is achieved because a stock acquisition structure does not create a legal change in the ownership of these underlying contracts and rights.
However, the transaction participants need well-considered income tax planning in order to avoid the potential negative tax consequences and complexities of a taxable stock purchase.
The corporate acquirer should be careful to ensure that both (1) the target company historical tax depreciation schedules are maintained and (2) the acquisition accounting entries for the GAAP accounting can be unwound.
This post-transaction recordkeeping consideration is in addition to the acquirer performing a Section 384 analysis if the target company has a net operating loss or a tax credit carryforward.
The purchase of C corporation stock by an S corporation may create an additional trap for the transaction participants—if the S corporation acquirer borrows the funds to finance the acquisition purchase price, then the interest expense will be treated as investment interest expense.
Even if the interest is tax deductible to the S corporation shareholder for federal income tax purposes, it may not be deductible for state income tax purposes.