S Corporation Mergers and Acquisitions: Tax Planning Strategies for Favorable Outcomes

Transcription

1 60TH ANNUAL MNCPA TAX CONFERENCE November 17-18, 2014 Minneapolis Convention Center ONLINE RESOURCES Session Handouts Most session handouts are available on the MNCPA website. To access: Go to Log in with your MNCPA username and password Note: Your conference registration fee must be paid in full to access session handouts online. CPE Transcript (Certificate of Attendance) Your official transcript will be available on the MNCPA website. To access: Go to Log in with your MNCPA username and password Note: Tax Conference transcripts will be available Friday, Nov. 21. MATERIALS DISCLAIMER These materials are provided for the exclusive, personal use of the customer. Any other reproduction, retransmission, republication or other use is expressly prohibited without prior written consent from the Minnesota Society of Certified Public Accountants (MNCPA) and/or the content author. The MNCPA makes no warranty, guarantee or representation as to the accuracy or completeness of these materials. The contents of these materials are subject to change without notice. The content authors and/or instructors are not engaged in rendering legal, accounting or professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. S Corporation Mergers and Acquisitions: Tax Planning Strategies for Favorable Outcomes Mark A. Sellner, CPA, JD, LLM (taxation) Sellner Tax Consulting, LLC Plymouth, MN Mark A. Sellner, CPA, JD, LLM (taxation), consults on business and executive tax matters, including the tax consequences of buying and selling a business. He is also an adjunct professor of business taxation at the University of St. Thomas School of Law and past director of graduate studies in taxation at the Carlson School of Management at the University of Minnesota. In addition, Sellner is currently serving a fouryear term on the Minnesota Board of Accountancy.

2 MNCPA CPE MORE CPE FROM MARK SELLNER Dec. 8 Advanced Tax Strategies for S Corporations (ASCORP) Gain a solid understanding about smart tax planning strategies for S Corporations, including how to use qualified subchapter S subsidiaries, how to reduce self-employment taxes on S Corporation earnings, how to apply the 3.8 percent Medicare tax and much more. Dec. 9 NEW! Tax Ethics: Real-World Application of the Rules (Live Webcast) (WCTERW01) 9-10:40 a.m. 2 Ethics credits Online via your computer Explore the sources of the rules governing tax ethics and find out which rules apply to you. Look at intriguing case studies and discover how to create an ethical tax practice culture. Dec. 16 Fundamentals of Taxation 2014: Staff Individual Tax Training (FTSTTI) Build a solid foundation of tax knowledge for your staff and make sure they re up to date on new legislation affecting individuals. At this in-depth course, they ll get guidance on filing status, exemptions, income, adjusted gross income, itemized deductions, AMT calculations and more. Dec. 17 Fundamentals of Taxation 2014: Staff Business Entity Tax Training (FTSTTB) Build a solid foundation of tax knowledge for your staff and make sure they re up to date on new legislation affecting businesses. At this in-depth course, they ll get guidance on gross income, deductions, repair deductions, capitalized costs, depreciation, Sec. 179 expensing and more. Jan. 22 Tax Update for Corporations and Pass-Through Entities (TUCP) Take an in-depth look at 2014 federal and state tax legislation, regulations and court cases affecting your business clients. Come away with tax-saving strategies and new planning ideas. Courses take place 8:30 a.m. - 4:30 p.m. at the MNCPA Education Center in Bloomington unless otherwise noted. Visit for detailed information and registration.

3 60 th Annual MNCPA Tax14Conference S Corporation Mergers and Acquisitions: Tax Planning Strategies for Favorable Outcomes November 17, 2014 Mark A. Sellner CPA, JD, LLM (taxation) (612) mark@sellnertaxconsulting.com 2014 Sellner Tax Consulting, LLC All Rights Reserved Session Description Want to learn more about the tax planning opportunities and pitfalls with the sale or purchase of an S Corporation? This is the session for you. Through a comprehensive case study, examine the mechanics of a Section 338(h)(10) or Section 336(e) election. 2 Page 1

4 Session Description Explore the potential seller's detriments and buyer's benefits that should be considered when negotiating the sale or purchase transaction. Discover how to maximize after-tax sales proceeds and minimize after-tax purchase costs. Plus, take a look at post-merger qualified subchapter S subsidiary (QSub) elections. 3 Topics I. Case Study Scenario II. Stock Sale Case Study III. Asset Sale Case Study IV. Section 338(h)(10) Case Study V. Section 336(e) Case Study VI. Section 338(h)(10) vs. Section 336(e) VII. QSub Case Study Page 2

5 Appendix A. Section 338(h)(10) Code and Regs B. Section 336(e) Code and Regs C. Holding Company Formation Case Study Scenario Buyer is a partnership. Target is an S corporation owned and operated by two shareholders. Target is valued at $6 million. Target has zero tax basis in its assets. Shareholders have zero tax basis in their stock. Page 3

6 Stock Sale Case Study Buyer 1 Shareholders 3 Target 2 1 Stock Purchase Agreement 2 Final Form 1120S and then Form Form 1040 Schedules D and E Stock Sale Case Study Legal Documents: 1. Stock Purchase Agreement between Buyer and Shareholders a. includes representations and warranties b. includes noncompete, employment, and/or consulting agreements Page 4

7 Stock Sale Case Study Tax Reporting: 2. Final Form 1120S U.S. Income Tax Return for an S Corporation filed by Target, then Form 1120 U.S. Corporation Income Tax Return 3. Form 1040 Schedule D Capital Gains and Losses and Schedule E Supplemental Income and Loss filed by Shareholders Stock Sale Case Study Tax Results: 1. Buyer has a $6 million tax basis in the stock of Target, now a C corporation. 2. Target has a zero carryover tax basis in its assets. 3. Shareholders have a $6 million long-term capital gain, taxed at a 20% federal rate and no 3.8% Medicare contribution tax. Page 5

8 Stock Sale Case Study It is unlikely that this stock sale transaction structure would be acceptable to Buyer, since there is a carryover tax basis of zero in the assets and the Target will be taxed as a C corporation going forward. Asset Sale Case Study Buyer 4 Shareholders 3 1 SMLLC assets Target 1 Asset Purchase Agreement and Asset Sale 2 Final Form 1120S with Form Form 1040 Schedules D and E 4 Form 1065 with Form Page 6

9 Asset Sale Case Study Legal Documents: 1. Asset Purchase Agreement between Buyer, Single Member Limited Liability Company, and Target a. includes representations and warranties b. includes noncompete, employment, and/or consulting agreements Asset Sale Case Study Tax Reporting: 2. Final Form 1120S U.S. Income Tax Return for an S Corporation with Form 8594 Asset Acquisition Statement Under Section 1060 filed by Target 3. Form 1040 Schedule D Capital Gains and Losses and Schedule E Supplemental Income and Loss filed by Shareholders Page 7

10 Asset Sale Case Study Tax Reporting: 4. Form 1065 U.S. Return of Partnership Income with Form 8594 Asset Acquisition Statement Under Section 1060 Asset Sale Case Study Tax Results: 1. Buyer has a $6 million stepped up tax basis in the assets acquired from Target. 2. Target computes a $6 million gain on the sale of its assets. 3. Shareholders have a $6 million separately stated gain, consisting of depreciation recapture and Section 1231 long-term capital gain. Page 8

11 Asset Sale Case Study It is likely that this asset sale transaction structure would be acceptable to Buyer, since there is a stepped up tax basis of $6 million in the assets. Shareholders may object to the structure if Target is subject to built-in gains tax or has significant depreciation recapture exposure. Section 338(h)(10) Case Study If an asset sale is acceptable to both the Buyer and the Shareholders, but there are business issues that would dictate a stock sale, the tax results of an asset sale and the legal results of a stock sale might be achieved with a stock sale combined with a Section 338(h)(10) election. Page 9

12 Section 338(h)(10) Case Study Buyer Corporate Buyer 1 Shareholders Target Stock Purchase Agreement with Section 338(h)(10) Election on Form Final Form 1120S with Form Form 1040 Schedule E 4 Form 1120 with Form 8883 and Form 1122 Section 338(h)(10) Case Study Legal Documents: 1. Stock Purchase Agreement between Buyer, Corporate Buyer, Target and Shareholders with a provision requiring a Section 338(h)(10) election and consistent tax treatment by all parties a. includes representations and warranties b. includes noncompete, employment, and/or consulting agreements Page 10

13 Section 338(h)(10) Case Study Legal Documents: Varying prices per share determined in arm s length negotiations between the Shareholders and the Corporate Buyer do not create a second class of stock that would disqualify the S corporation or the Section 338(h)(10) election. Section 338(h)(10) Case Study Tax Reporting: Section 338(h)(10) election on Form 8023 Elections Under Section 338 for Corporations Making Qualified Stock Purchases signed by Corporate Buyer and all Shareholders, filed with the IRS by Corporate Buyer. Page 11

14 Section 338(h)(10) Case Study Tax Reporting: 2. Final Form 1120S U.S. Income Tax Return for an S Corporation with Form 8883 Asset Allocation Statement Under Section 338 filed by Target 3. Form 1040 Schedule E Supplemental Income and Loss filed by Shareholders Section 338(h)(10) Case Study Tax Reporting: 4. Form 1120 U.S. Corporation Income Tax Return with Form 8883 Asset Allocation Statement Under Section 338 and election to file a consolidated return on Form 1122 Authorization and Consent of Subsidiary Corporation To Be Included in a Consolidated Income Tax Return filed by Corporate Buyer Page 12

15 Section 338(h)(10) Case Study Tax Reporting: If the Corporate Buyer were itself an S corporation, a qualified subchapter S subsidiary (QSub) election typically would be made on Form 8869 Qualified Subchapter S Subsidiary Election. Section 338(h)(10) Case Study Tax Results: 1. Corporate Buyer has a $6 million stepped up tax basis in the assets held by New Target. 2. Old Target computes a $6 million gain on the sale of its assets. 3. Shareholders have a $6 million separately stated gain, consisting of depreciation recapture and Section 1231 long-term capital gain. Page 13

16 Section 338(h)(10) Case Study It is unlikely that this stock sale transaction structure combined with a Section 338(h)(10) election would be acceptable to Buyer, since a Corporate Buyer is required in a Section 338(h)(10) election. Because Buyer is a partnership and therefore not an eligible S corporation shareholder, Corporate Buyer is not eligible to make an S election, so the Corporate Buyer and the Target will be taxed as C corporations. Section 338(h)(10) Case Study When Buyer is an S corporation or an individual incorporating a corporate buyer, a Section 338(h)(10) election is a common alternative to an asset purchase in the acquisition of an S corporation. Page 14

17 Section 336(e) Case Study A Section 338(h)(10) election is not available if the buyer is not a corporation. For an individual or an entity ineligible to be a shareholder of an S corporation buyer, the tax results of an asset sale and the legal results of a stock sale could be achieved with a stock sale combined with a Section 336(e) election. Section 336(e) Case Study If a Section 336(e) election is made, the S corporation shareholders are treated as not having sold the stock disposed of in the qualified stock disposition. Instead, the old S corporation is treated as selling its assets to a new corporation at the close of the disposition date. 30 Page 15

18 Section 336(e) Case Study Old S corporation realizes the deemed disposition tax consequences from the deemed asset disposition before the close of the disposition date while it still is owned by the S corporation shareholders. 31 Section 336(e) Case Study New corporation is treated as acquiring all of its assets from old S corporation in a single transaction at the close of the disposition date. If the Buyer is an eligible shareholder, a new S election may be made for the new corporation. 32 Page 16

19 Section 336(e) Case Study A Section 336(e) election for an S corporation target is made by completing the following requirements: (i) All of the S corporation shareholders and the S corporation target must enter into a written, binding agreement, on or before the due date including extensions of the federal income tax return of the S corporation target for the taxable year that includes the disposition date, to make a Section 336(e) election; 33 Section 336(e) Case Study (ii) the S corporation target must retain a copy of the written agreement; and (iii) the S corporation target must attach the Section 336(e) election statement to its timely filed including extensions federal income tax return for the taxable year that includes the disposition date. 34 Page 17

20 Section 336(e) Case Study The contents of the Section 336(e) election statement are provided in Reg. Sec (h)(5) and (6). Old S corporation and new corporation must report information concerning the deemed sale of the assets on Form 8883 Asset Allocation Statement Under Section 338, making appropriate adjustments to report the results of the Section 336(e) election, or on any successor form not yet prescribed by the Internal Revenue Service. 35 Section 336(e) Case Study 5 Buyer 1 Shareholders Target Stock Purchase Agreement 2 Section 336(e) Agreement with T and Election Statement 3 Final Form 1120S with Election Statement and Form 8883, then Form 1120 or Form 2553 with Form Form 1040 Schedule E 5 Form 1065 or Form 1040 Page 18

21 Section 336(e) Case Study Legal Documents: 1. Stock Purchase Agreement between Buyer and Shareholders with a provision requiring a Section 336(e) election and consistent tax treatment by all parties a. includes representations and warranties b. includes noncompete, employment, and/or consulting agreements Section 336(e) Case Study Tax Reporting: 2. Section 336(e) written, binding agreement signed by all Shareholders and old S corporation, with a copy retained by old S corporation Page 19

22 Section 336(e) Case Study Tax Reporting: 3. Final Form 1120S U.S. Income Tax Return for an S Corporation with Section 336(e) election statement and Form 8883 Asset Allocation Statement Under Section 338, making appropriate adjustments to report the results of the Section 336(e) election 4. Form 1040 Schedule E Supplemental Income and Loss filed by Shareholders Section 336(e) Case Study Tax Reporting: 5. Buyer files Form 1040 U.S. Individual Income Tax Return or the appropriate business entity income tax return Page 20

23 Section 336(e) Case Study Tax Results: 1. New corporation has a $6 million stepped up tax basis in the assets. 2. Old S corporation computes a $6 million gain on the sale of its assets. 3. Shareholders have a $6 million separately stated gain, consisting of depreciation recapture and Section 1231 long-term capital gain. Section 338(h)(10) vs. Section 336(e) 338(h)(10) 336(e) Corporate buyer required? Yes No 80%+ taxable stock purchase? QSP QSD Stepped up tax basis in assets? Yes Yes Assets held in new Target? Yes Yes S election if eligible? Yes Yes Related party restrictions? Yes Yes Election due date 8 1/2 mo. Return Page 21

24 QSub Case Study Section 1361(b)(3) Treatment of Certain Wholly Owned Subsidiaries Form 8869 Qualified Subchapter S Subsidiary Election The IRS may grant S corporations an extension to elect to treat a subsidiary as a Q Sub under Rev. Proc QSub Case Study S Corporation Cost = $500,000 Q Sub Tax Basis of Assets = $50,000 What are the federal tax consequences if S corporation buys 100% of the stock of another corporation for $500,000 and makes a QSub election? Page 22

25 QSub Case Study Shareholder 1 Shareholder 2 Shareholder 3 Shareholder 4 Shareholder 5 Shareholder 6 Company 1 Company 2 Company 3 Company 4 Company 5 Company 6 (S Corporation) (S Corporation) (S Corporation) (S Corporation) (S Corporation) (S Corporation) QSub Case Study Shareholder 1 Shareholder 2 Shareholder 3 Shareholder 4 Shareholder 5 Shareholder 6 Company 1 (S Corporation) Company 2 (QSub) Company 3 (QSub) Company 4 (QSub) Company 5 (QSub) Company 6 (QSub) What is the impact on suspended losses if the group is restructured to allow for QSub elections? Page 23

26 QSub Case Study For more information on restructuring with QSubs, see Sellner, The Use of QSubs in S Corporation Tax Planning, The Footnote, October 2012 at Appendix A. Section 338(h)(10) Code and Regs B. Section 336(e) Code and Regs C. Holding Company Formation Page 24

27 Section 338(h)(10) Code and Regs Section 338 Certain Stock Purchases Treated As Asset Acquisitions (a) General Rule. if a purchasing corporation 1 makes an election 2 then, in the case of any qualified stock purchase 3, the target corporation 4-1. a corporate buyer, either C or S, is required 2. a joint election is made on Form a taxable stock purchase of at least 80% of the stock 4. old target is treated as selling its assets to new target Section 338(h)(10) Code and Regs Section 338 Certain Stock Purchases Treated As Asset Acquisitions (1) shall be treated as having sold all of its assets 5 at fair market value, and (2) shall be treated as a new corporation 6 which purchased all of the assets 7 referred to in paragraph (1) 5. the stock sale by the shareholders is disregarded 6. new target is acquired by the corporate buyer 7. new target assets have a stepped up tax basis Page 25

28 Section 338(h)(10) Code and Regs Section 338 Certain Stock Purchases Treated As Asset Acquisitions (b) Basis of Assets After Deemed Purchase. (5) Allocation among assets. The amount determined under paragraphs (1) and (2) shall be allocated 8 among the assets of the target corporation under regulations prescribed by the Secretary. 8. unlike an asset sale on Form 8594, a joint allocation is made on Form 8883 Section 338(h)(10) Code and Regs Section 338 Certain Stock Purchases Treated As Asset Acquisitions (d) Purchasing Corporation; Target Corporation; Qualified Stock Purchase. Page 26

29 Section 338(h)(10) Code and Regs Section 338 Certain Stock Purchases Treated As Asset Acquisitions (g) Election. (1) When made. an election under this section shall be made not later than the 15 th day of the 9 th month beginning after the month in which the acquisition date occurs the corporate buyer and all shareholders sign Form 8023 Section 338(h)(10) Code and Regs Section 338 Certain Stock Purchases Treated As Asset Acquisitions (h) Definitions and Special Rules. (10) Elective recognition of gain or loss by target corporation, together with nonrecognition of gain or loss on stock sold by selling consolidated group Section 338(h)(10) applies to the sale of C corporation subsidiaries; the regulations expand it to S corporations Page 27

30 Section 338(h)(10) Code and Regs Reg. Sec (h)(10)-1 Deemed Asset Sale and Liquidation (c) Section 338(h)(10) Election (1) In general. A Section 338(h)(10) election may be made for T if P acquires stock meeting the requirements of Section 1504(a)(2) 11 from a selling consolidated group, a selling affiliate, or the S corporation shareholders in a qualified stock purchase. 11. at least 80% of the stock is purchased Section 338(h)(10) Code and Regs The [1994] final regulations provide that a Section 338(h)(10) election may be made if T is an S corporation immediately before the acquisition date. The deemed sale gain is reported on T's final S corporation return and therefore is taken into account under Sections 1366 and 1367 in determining a T shareholder's basis in the T stock and resulting gain or loss on the deemed liquidation of T. [continued] Page 28

31 Section 338(h)(10) Code and Regs The Section 338(h)(10) election must be made jointly by P and the T shareholders. The instructions to the revised Form 8023 will provide more guidance on making the election. TD 8515, January 20, 1994 Section 336(e) Code and Regs Section 336 Gain or Loss Recognized on Property Distributed in Complete Liquidation (e) Certain Stock Sales and Distributions May Be Treated as Asset Transfers Under regulations prescribed by the Secretary, if - (1) a corporation owns stock in another corporation meeting the requirements of Section 1504(a)(2), and (2) such corporation sells, exchanges, or distributes all of such stock, 58 Page 29

32 Section 336(e) Code and Regs an election may be made to treat such sale, exchange, or distribution as a disposition of all of the assets of such other corporation, 1 and no gain or loss shall be recognized on the sale, exchange, or distribution of such stock. 1. Section 336(e) applies to the sale of C corporations; the regulations expand it to S corporations 59 Section 336(e) Code and Regs Like Section 338(h)(10), Section 336(e) applies to S corporations by regulation. The Section 336(e) regulations apply to any qualified stock disposition for which the disposition date is on or after May 15, Page 30

33 Holding Company Formation Shareholders Old S Corporation Holding Company Formation Shareholders Old S Corporation 2 1 Articles of Incorporation 2 Contribution Agreement 3 Form 1120S 4 Form 8869 Newco S Corporation Old S Corporation Now QSub Page 31

34 Holding Company Formation Legal Documents: 1. Articles of Incorporation to Form Newco S Corporation 2. Contribution Agreement between Shareholders and Newco S Corporation for Transfer of S Corporation Stock Holding Company Formation Tax Reporting: 3. Form 1120S U.S. Income Tax Return for an S Corporation with Section 351 and Section 368(a)(1)(F) disclosures. No Form 2553 Election By a Small Business Corporation is required for Newco S Corporation 4. Form 8869 Qualified Subchapter S Subsidiary Election Page 32

35 Holding Company Formation Tax Results: S Corporation has been converted into a disregarded entity as a QSub of Newco S Corporation. The QSub retains the EIN of S Corporation for purposes of employment tax purposes. Newco S Corporation must obtain a new EIN. Rev. Rul Disclaimer The information included and discussed in this presentation is general in nature and should not be relied upon in providing tax and accounting advice without independent research and analysis. A lawyer should be consulted regarding any legal advice. Specific client advice should be provided only after independent tax research and analysis. 66 Page 33

36 This page is intentionally blank.

37 60TH ANNUAL MNCPA TAX CONFERENCE November 17-18, 2014 Minneapolis Convention Center, Minneapolis, MN Please rate the following using the scale below: 5=Excellent, 4=Very Good, 3=Average, 2=Fair, 1=Poor B3. S Corporation Mergers and Acquisitions: Tax Planning Strategies for Favorable Outcomes Excellent Poor Relevancy of Topic Stated Objectives Met Overall Satisfaction Mark A. Sellner, CPA, JD, LLM (taxation) Knowledge of Subject Presentation Skills Quality of Materials Engagement of Participants Do you have any additional feedback regarding the instructor and/or materials? If so, please share it with us. What would you like to learn at the 2015 conference? Who would you like to hear speak at the 2015 conference? Thank you for your feedback and suggestions. We appreciate your input. Minnesota Society of Certified Public Accountants