Considerations in Selling a Business August 16, Session Description. Learning Objectives

Transcription

1 Considerations in Selling a Business August 16, 2013 Mark A. Sellner CPA, JD, LLM (taxation) (612) mark@sellnertaxconsulting.com 2013 Sellner Tax Consulting, LLC All Rights Reserved Session Description This session highlights tax issues and planning opportunities involved in the sale of an S-Corp or LLC. Case studies point out potential buyer s benefits and seller s detriments that should be considered by a client in negotiating a sale, with the goal of maximizing after-tax sales proceeds. Learning Objectives By the end of the session, you will be able to: 1. identify tax issues and planning opportunities involved in the sale of an S-Corp or LLC 2. understand potential buyer s benefits and seller s s detriments in negotiating a sale 3. explain how to maximize after-tax sales proceeds 4. minimize the new 3.8% tax on the sale of a business 1

2 Agenda 1. Overview of Taxable and Tax-Free Sale Transactions 2. Taxable Sale of S-Corp Stock and Reverse Cash Merger 3. Taxable Sale of S-Corp Assets and Forward Cash Merger Agenda 4. Acquisitions Involving S Corporations 5. Acquisitions Involving LLCs 6. Application of the New 3.8% Tax 1. Overview of Taxable and Tax-Free Sale Transactions Technical Resources Roles and Responsibilities of the Tax Adviser Importance of Legal and Tax Structure Transaction Structures 2

3 Technical Resources Ginsburg & Levin, Mergers, Acquisitions, and Buyouts McKee, Nelson & Whitmire, Federal Taxation of Partnerships and Partners Roles and Responsibilities of the Tax Adviser Technical Expertise Federal Tax State and Local Tax International Tax Functional Expertise Tax Planning Tax Compliance Tax Audit Roles and Responsibilities of the Tax Adviser Transactional Expertise Transaction Structuring Tax Elections Tax Modeling of After-Tax Costs/Benefits Tax Return Reporting Tax Advice under Treasury Circular 230 3

4 Importance of Legal and Tax Structure ( ) Principal Non-Tax Issues Liability Assumption T Representations, Warranties, Indemnifications Employment Contracts, Covenants Not to Compete 1 References are to Ginsburg & Levin, Mergers, Acquisitions, and Buyouts Importance of Legal and Tax Structure ( ) Principal Tax Issues Corporate-Level Tax Shareholder Tax Importance of Legal and Tax Structure Availability of Installment Method ( 106.4) Uncertain Tax Rate Environment Tension Between Tax Deferral for Seller and Credit Risk of Buyer The Collateral May be the T Business That Cannot Service the Installment Payments 4

5 Importance of Legal and Tax Structure Allocation of Amounts Paid by P ( 106.8) Tax Benefit of an Asset Transaction Depends on the Present Value of Tax Savings Attributable to SUB, if Any Discussion Question Assume a $1 million purchase price for a business, all allocated to goodwill. The buyer has a 40% tax rate and an 8% cost of capital. What is the approximate tax benefit of an asset purchase versus a stock purchase? Importance of Legal and Tax Structure Unwanted Assets ( ) Separating T s Unwanted Assets Generally Results in Corporate-Level Gain Under Section 1001 or Section 311(b) Importance of Legal and Tax Structure State and Local Taxes ( ) Critical Issue to be Addressed During Tax Due Diligence and Transaction Structuring Consider Sales Taxes and Transfer Taxes as Well, Both on Consider Sales Taxes and Transfer Taxes as Well, Both on Prior Operations and on the Sale Transaction 5

6 Transaction Structures ( 105) Transaction Structure Stock Assets Taxable Tax-Free Taxable Tax-Free Direct Stock Purchase Reverse Cash Merger B Reorganization Reverse Merger Direct Asset Purchase Forward Cash Merger Section 338 Election A Reorganization C Reorganization Forward Merger Taxable Sale of S-Corp Stock and Reverse Cash Merger Taxable Stock Transactions Summary of Taxable Stock Transactions Acquisition Steps-Reverse Cash Merger Escrow to Secure Seller s Representations and Warranties Treatment of P and T If Code 338 Election Is Made Taxable Stock Transactions Transaction Structure Stock Assets Taxable Tax-Free Taxable Tax-Free Direct Stock Purchase Reverse Cash Merger B Reorganization Reverse Merger Direct Asset Purchase Forward Cash Merger Section 338 Election A Reorganization C Reorganization Forward Merger 18 6

7 Summary of Taxable Stock Transactions T Shareholders Transaction Structure Taxable Stock Taxable Assets 1001 T Shareholders Capital Gain or Loss 1001 T s Gain or Loss on Asset Sale 1001 T Shareholders Gain or Loss on Stock Redemption Summary of Taxable Stock Transactions Purchaser s Transaction Structure Taxable Stock Taxable Assets 1012 P Cost Basis in T Stock T Asset COB 1060 Purchase Price Allocation to Assets Acquired from T 168 Depreciation of Tangible Assets 197 Amortization of Goodwill 20 Acquisition Steps-Reverse Cash Merger ( 202) P Cash and/or P notes Selling Shareholders Newco Reverse subsidiary cash merger T 21 7

8 Acquisition Steps-Reverse Cash Merger ( 202) P T Taxable reverse subsidiary merger treated like taxable stock purchase [Rev. Rul ] 22 Escrow to Secure Seller s Representations and Warranties ( ) When the security arrangement protects the buyer, there should be no constructive receipt and the installment method should be available. IRS Publication 537 Installment Sales 23 Treatment of P and T If Code 338 Election Is Made ( 205) A regular Section 338 election is much different than a Section 338(h)(10) election. When available, Section 338(h)(10) is generally far more desirable. A qualified stock purchase is required for either a regular Section 338 election or a Section 338(h)(10) election. 24 8

9 Treatment of P and T If Code 338 Election Is Made ( 205) A C or S Corporation buyer is required for either a regular Section 338 election or a Section 338(h)(10) election. It is generally thought that there is no business purpose requirement for a Section 351 incorporation This would allow the incorporation of P for the purpose of making a qualified stock purchase Taxable Sale of S-Corp Assets and Forward Cash Merger Taxable Asset Transactions Summary of Taxable Asset Transactions Treatment of P, T, and Selling Shareholder(s) If Code 338(h)(10) Election Is Made Acquisition Steps-Forward Cash Merger Treated Like Taxable Purchase of Assets 3. Taxable Purchase of T s Assets and Forward Cash Merger Allocation of Sales Price Case Study Payments for Services, Non-Compete Covenants, and Personal Goodwill 9

10 Taxable Asset Transactions Transaction Structure Stock Assets Taxable Tax-Free Taxable Tax-Free Direct Stock Purchase Reverse Cash Merger B Reorganization Reverse Merger Direct Asset Purchase Forward Cash Merger Section 338 Election A Reorganization C Reorganization Forward Merger 28 Summary of Taxable Asset Transactions T Shareholders Transaction Structure Taxable Stock Taxable Assets 1001 T Shareholders Capital Gain or Loss 1001 T s Gain or Loss on Asset Sale 1001 T Shareholders Gain or Loss on Stock Redemption 29 Summary of Taxable Asset Transactions Purchaser s Transaction Structure Taxable Stock Taxable Assets 1012 P Cost Basis in T Stock T Asset COB 1060 Purchase Price Allocation to Assets Acquired from T 168 Depreciation of Tangible Assets 197 Amortization of Goodwill 30 10

11 Treatment of P, T, and Selling Shareholder(s) If Code 338(h)(10) Election Is Made ( 206) P s purchase of T s stock, but new T is treated as purchasing old T s assets Selling shareholders are treated as having exchanged their stock incident to T s complete liquidation 31 Treatment of P, T, and Selling Shareholder(s) If Code 338(h)(10) Election Is Made ( 206) Section 338(h)(10) is only available for a QSP if T is a member of Bigco s consolidated group, T is a member of Bigco s affiliated group, or T is an SCo 32 Treatment of P, T, and Selling Shareholder(s) If Code 338(h)(10) Election Is Made ( 206) Where T is an SCo, T-SCo recognizes gain or loss on deemed asset sale, Gain or loss passes through to T-SCo shareholders, T-SCo shareholders adjust their stock basis, and T-SCo shareholders surrender their stock in complete liquidation of T-SCo 33 11

12 Treatment of P, T, and Selling Shareholder(s) If Code 338(h)(10) Election Is Made Where T is an SCo, the absence of double taxation does not mean that T-SCo s shareholders are indifferent to a Section 338(h)(10) election versus a stock sale Section 338(h)(10) may produce ordinary income Section 338(h)(10) may produce ordinary income and capital loss Section 338(h)(10) may produce corporate built-in gains tax or corporate state tax Section 338(h)(10) may produce higher state taxes 34 Acquisition Steps-Forward Cash Merger Treated Like Taxable Purchase of Assets ( 301) Example 1. P s Taxable Purchase of T s Assets Selling Shareholders Purchase of T assets P Cash and/or P notes T 35 Acquisition Steps-Forward Cash Merger Treated Like Taxable Purchase of Assets ( 301) P Cash and/or P notes Selling Shareholders Newco Forward subsidiary cash merger T 36 12

13 Acquisition Steps-Forward Cash Merger Treated Like Taxable Purchase of Assets ( 301) P Newco (T assets) Taxable forward subsidiary merger treated like taxable asset purchase [Rev. Rul. 69-6] 37 Allocation of Sales Price Case Study Dick is selling the assets of his S corporation grocery store business to Red Owl for $4.5 million in a taxable asset transaction. What are the tax reporting responsibilities of Dick and Red Owl? 38 Allocation of Sales Price Case Study Agreement of Parties as to Allocation ( ) Form 8594 Asset Acquisition Statement Under Section Did the purchaser and seller provide for an allocation of the sales price in the sales contract or in another written document signed by both parties? If Yes, are the aggregate fair market values (FMV) listed for each of asset Classes I, II, III, IV, V, VI, and VII the amounts agreed upon in your sales contract or in a separate written document? 39 13

14 Allocation of Sales Price Case Study Code 338 or 338(h)(10) Stock Purchase ( ) Class I Class II Class III Class IV Class V Class VI Class VII Cash Certificates of deposit Debt instruments Inventory Machinery, equipment, real estate Intangibles Goodwill 40 Allocation of Sales Price Case Study SAMPLE ASSET PURCHASE AGREEMENT Section 3.4 Allocation of Purchase Price. Seller and Purchaser agree to allocate the Purchase Price in accordance with Section 1060 of the Code. Seller and Purchaser agree that Purchaser shall prepare and provide to Seller a draft allocation of the Purchase Price among the Assets Allocation of Sales Price Case Study Section 3.4. In addition, Seller and Purchaser hereby undertake and agree to file timely any information that may be required to be filed pursuant to Treasury Regulations promulgated under Section 1060(b) of the Code, and shall use the allocation determined pursuant to this Section 3.4 in connection with the preparation of IRS Form 8594 as such form relates to the transactions contemplated by this Agreement 14

15 Payments for Services, Non-Compete Covenants, and Personal Goodwill ( 404.1) PAYMENT T EXEC FICA/SE P REPORT Employment OI Yes Deduct Form W-2 Consulting OI Yes Deduct Form 1099 Non-Compete OI No 15-year Form 1099 Personal GW CG No 15-year Purchase Agreement OI = ordinary income CG = capital gain GW = goodwill 43 Payments for Services, Non-Compete Covenants, and Personal Goodwill ( 404.1) Non-Compete Covenant ( ) Form 8594 Asset Acquisition Statement Under Section In the purchase of the group of assets (or stock), did the purchaser also purchase a license or a covenant not to compete, or enter into a lease agreement, employment contract, management contract, or similar arrangement with the seller (or managers, directors, owners, or employees of the seller)? If Yes, attach a schedule that specifies (a) the type of agreement and (b) the maximum amount of consideration (not including interest) paid or to be paid under the agreement. See instructions. 44 Payments for Services, Non-Compete Covenants, and Personal Goodwill ( 404.1) Sale of Personal Goodwill ( ) Payments directly to T shareholders may avoid double tax with a C corporation Payments directly to T-SCo shareholders may avoid built-in gains tax and depreciation recapture Note that there were no covenant not to compete or employment agreement in Martin Ice Cream 45 15

16 4. Acquisitions Involving S Corporations ( 1101) S-Corp as Seller Section 338(h)(10) Case Study Negotiating Points in Selling an S-Corp 46 S-Corp as Seller For T-SCo, consider a taxable asset purchase, a forward cash merger, or a Section 338(h)(10) election Beware of Section 1374 built-in gains tax and Section 1245 depreciation recapture Verify state tax treatment 47 Section 338(h)(10) Case Study Dick and his wife have gifted stock in their S Corporation Dick s Grocery Store to their children over the years, and are now concerned that, without income from the grocery business, they may have been too generous in gifting away a significant part of their retirement nest egg. Dick and his wife are considering a sale of the company. Can they take a disproportionate amount of the sales proceeds? 48 16

17 Section 338(h)(10) Case Study Shareholders Buyer S Corporation Step 1 Sale of S Corporation Stock for Cash, with Per Share Price Negotiated by Individual Shareholders Step 2 Joint Election by Shareholders and Buyer under IRC Section 338(h)(10) to Treat the Stock Sale as an Asset Sale for Federal Income Tax Purposes Step 3 S Corporation Reports Deemed Asset Sale in the Amount of the Stock Sales and Reports Gain to Shareholders Prorata 49 Negotiating Points in Selling an S-Corp Get paid for P s tax deductible goodwill Get reimbursed for T s depreciation recapture Get reimbursed for T s built-in gains tax Consider different prices for different blocks of stock Acquisitions Involving LLCs Purchase of LLC Interests Tax-Free Acquisition by LLC Case Study Redemption Case Study 51 17

18 Purchase of LLC Interests A purchaser who acquires 100 percent of the interests in a partnership is treated as acquiring the partnership assets directly by purchase even if the transaction is structured as a purchase of partnership interests. t (Rev. Rul. 99-6) See McKee, Nelson & Whitmire, Federal Taxation of Partnerships & Partners (WG&L) 52 Tax-Free Acquisition by LLC Case Study A limited liability company proposes to acquire the assets of an S corporation by issuing LLC interests valued at $3.5 million plus $700,000 in cash. What are the federal income tax consequences of the proposal? 53 Tax-Free Acquisition by LLC Case Study Target S Corporation Shareholders Target S Corporation Acquiring LLC Members Acquiring LLC 54 18

19 Redemption Case Study Harry has gifted interests in his LLC to his children for several years. He now intends to completely retire from the business and would like to create a stream of retirement income from the LLC, preferably at capital gains tax rates. Discuss alternatives and the related federal income tax consequences. 6. Application of the New 3.8% Tax Section 1411 Imposition of Tax (c)(1) Net investment income In general The term net investment income means the excess (if any) of- (A) (iii) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business, over (B) the deductions allowed by this subtitle which are properly allocable to such gross income or net gain. 56 Application of the New 3.8% Tax Section 1411 Imposition of Tax (c)(4) Exception for certain active interests in partnerships and S corporations In the case of a disposition of an interest in a partnership or S corporation

20 Application of the New 3.8% Tax Section 1411 Imposition of Tax (c)(4) Exception for certain active interests in partnerships and S corporations (A) gain from such disposition shall be taken into account under clause (iii) of paragraph (1)(A) only to the extent of the net gain which would be so taken into account by the transferor if all property of the partnership or S corporation were sold for fair market value immediately before the disposition of such interest, 58 Learning Objectives By the end of the session, you will be able to: 1. identify tax issues and planning opportunities involved in the sale of an S-Corp or LLC 2. understand potential buyer s benefits and seller s s detriments in negotiating a sale 3. explain how to maximize after-tax sales proceeds 4. minimize the new 3.8% tax on the sale of a business Disclaimer The information included and discussed in this presentation is general in nature and is not a basis for providing tax and accounting advice without independent research and analysis. Under Circular 230, this presentation is not written to be used, and may not be used, by a taxpayer to avoid penalties. The content and views expressed in this presentation are solely those of the presenter. 20