The process of acquisition due diligence requires careful coordination with your tax and legal team. If you’re planning an acquisition, you may be able to take advantage of tax structuring and special tax elections, resulting in a more favorable transaction that meets your strategic and financial objectives.
Working proactively to create a formal due diligence plan with your tax and legal team can help avoid surprises and enhance tax efficiencies. During the due diligence process, buyers should seek to understand where the risks may be hidden relative to the target company and determine how to best structure the transaction for current and future tax benefits.
The two main tax elections buyers should be aware of are elections under 338(h)(10) and 336(e).
The 338(h)(10) election can allow the buyer to obtain the best of both worlds with the ability to treat the transaction for legal purposes as a ‘stock sale’, yet also receive all the tax benefits provided in an ‘asset sale’. From a seller’s perspective, these elections might be tax-neutral or, in certain situations, result in more tax. Often in an acquisition, the buyer desires to assimilate contracts and licenses from the seller without reapplication or additional costs, making a stock transaction from a practicality standpoint more attractive.
The 336(e) election achieves comparable positive effects for the buyer, with the unique distinction that this election also brings into the fold additional eligible buyers such as individuals, partnerships, or other noncorporate entities.
While both elections achieve the same goal of allowing the buyer to “step up” the target corporation’s assets to fair market value and further depreciate these assets for current and future tax benefits, there are some distinctions between the two elections:
Under 336(e):
- The purchaser is not required to be a corporation.
- The seller(s) may be any domestic corporation or shareholders of an S Corporation that makes a qualified stock disposition.
- The corporation may be converted to a flow-through entity post-acquisition.
Under 338(h)(10):
- The purchaser is required to be a C Corporation or an S Corporation.
- The seller(s) must be a corporate subsidiary of a parent company or an S Corporation.
Other key differences:
- 336(e) allows the taxpayer to aggregate all target stock sold, distributed, or exchanged whereby 338(h)(10) requires a single purchasing corporation.
- 338(h)(10) requires unilateral consent from both the seller and the acquirer, whereby 336(e) is exclusively made by the seller.
- While 338(h)(10) requires the purchase of at least 80% of the target stock, 336(e) applies to any combination of exchanges, sales, or distributions equaling at least 80% of the target stock
Both of these elections are fairly complex and require specific elections, precise timing, stock basis considerations, and other disclosures that are beyond the scope of this article.
Newburg CPA, a mid-size accounting firm located just outside Boston, Massachusetts, has many years of M&A due diligence experience assisting both buyers and sellers in transactions. We work closely with your attorney to ensure that you avoid surprises and minimize your overall tax exposure when engaging in an important M&A transaction.