The following article is reprinted from The M&A Tax Report, Vol. 12, No. 10, May 2004, Panel Publishers, New York, NY.


By Robert W. Wood

Taxes are complex and arcane, perhaps no where more so than in the world of M&A. As I'm sure you know, most merger or acquisition transactions have significant tax implications. The transaction may be structured as taxable sales, in which the target's stock is being purchased or the target is selling its assets and then being liquidated. Alternatively, the transaction may be structured as a nontaxable reorganization involving an exchange of stock. In the latter case, they may either be wholly tax-free or partially tax-free depending on the various types of consideration given to the target and/or its shareholders. The consideration can include cash, common or preferred stock, promissory notes, and even contractual earnout rights. The type and amount of tax will vary with the type and amount of these classes of consideration.

Given all these various permutations, it will be a rare transaction in which one or more tax lawyers have not been asked to examine the tax consequences for both the buyer and the seller. At the very least, this will come up at tax return time, the year after the deal closes. However, since it will almost always be too late then to do much more than write a check to the IRS or state taxing authorities, M&A tax work generally begins much earlier on. Indeed, in most cases tax lawyers will have thoroughly considered the various tax planning avenues that may be availed of to minimize the tax consequences of the transaction.

Typically, this kind of tax structuring occurs during the planning stages of the acquisition, certainly well before the closing occurs. Indeed, optimally these discussions take place before the letter of intent is even signed. The appropriate record should start early on, before a trail of correspondence and documents may seal the fate of any kind of effective tax reduction techniques.

Competing Tax Considerations

From a buyer's tax viewpoint, the buyer will generally want to achieve a step-up in the tax basis of the assets, thus affording higher depreciation deductions in the future. The buyer will also want to have the benefit of any tax attributes of the target that the buyer thinks are attractive.

In many cases, these tax goals are mutually exclusive. The buyer may therefore have to decide which tax issues are most important to it. Then, the interaction with the seller must occur. In almost all cases the buyer and seller will have competing tax interests that can make for some heated negotiations (never seen that before!). Whose tax interest is more important? Who will pay which tax liabilities? Which tax risks should be the subject of a tax indemnity obligation?

State and Local Taxes, Too

As if all of this did not make the tax issues in M&A deals interesting enough, there will often be state tax consequences, too. Sales and use taxes on assets sales, for example, can be costly to put it mildly. They can also dramatically impact reporting obligations after the transaction is complete.

Not only will these state tax issues need to be considered, but like federal income taxes, they will enter into the bargaining over the business terms. If state and local sales or use taxes are payable, either the buyer, the seller, or some combination thereof, will have to pay them. Of course, there may even be sales and use taxes paid in several states. Buyers and sellers often end up agreeing to split sales and use tax liabilities, but there is no absolute standard for this.

Apart from state and local sales taxes, other state taxes can prove nettlesome, too. These state tax issues don't necessarily follow the federal tax law treatment. The state tax issues can include state corporate income taxes or state franchise taxes. Obviously, the more states in which the target company or the acquiring company does business, the more state tax issues there will be.

Peace-I'm Out

Most tax lawyers agree that the Internal Revenue Code and the Treasury Regulations contain a considerable volume of material that is nearly Herculean to try to master. Taking a more modest goal, even if one focuses only on one chapter of the dozens in the Tax Code-the rather lengthy provisions dealing with mergers and acquisitions-the task can be daunting. Yet, even this large amount of reading (and the accompanying expertise that will hopefully develop) will not be enough in many cases. A significant body of tax law has developed over the last fifty years that is actually not included in the Internal Revenue Code at all, and, in large part, it's not even included in the IRS' own regulations. These nonstatutory doctrines (based on case law) serve as a general overlay to the tax treatment of mergers and acquisitions.

Don't Wait Until It's Too Late — Address Tax Issues in M&A Deals Sooner Rather Than Later, Vol. 12, No. 10, The M&A Tax Report (May 2004), p. 3.