How are My Taxes Impacted in a Stock Deal vs. an Asset Deal?
When it comes to selling a business, clearly understanding the tax implications for both the Buyer and the Sellers is crucial in negotiating the final deal structure. With over 30 years as an M&A consultant, Summit Advisory has seen a wide array of deal structures, and understands the catalysts behind when and why they might be selected. Two of the most common deal structures when selling a business are known as a stock deal, or an asset deal. Each method has distinct tax consequences, or benefits, depending on which side of the transaction you’re on. In this article, we explore some of the differences between these two structures, and highlight a number of the tax implications based on the deal structure selected.
A stock deal and an asset deal are two different approaches to structuring the sale or acquisition of a company. Let’s explore the differences between these two types of transactions:
In a stock deal, the buyer purchases the shares of the target company directly from the existing shareholders (Sellers). Some of the key characteristics of a stock deal include:
- Ownership Transfer: Typically, the ownership of the entire company, including its assets, liabilities, and legal risk & obligations, employees, contracts, clients, etc. are all transferred to the buyer. Other than a change in the ownership structure, the Company, its contracts, insurance, benefits, etc. are the same the day after a transaction as they were the day prior to it. Although some transactions may be executed for a portion of the business, (say 25% or 50%), a typical transaction includes all shares of the Company (100%).
- Continuity: The target company continues to operate as an ongoing entity, with its existing contracts, permits, licenses, and legal status intact. The buyer essentially steps into the shoes of the previous shareholders, acquiring the company as a whole.
- Tax Implications: In a stock deal, the buyer inherits the target company’s tax attributes, such as its tax basis in its assets. This can have tax advantages or disadvantages depending on the specific circumstances. Capital gains taxes are typically paid by the seller on the proceeds from the sale of their shares. See more on this below.
- Liabilities: The buyer assumes the target company’s known and unknown liabilities, including any legal claims, debts, or contingent obligations. In a stock deal, the structure typically assumes the Seller will take any cash in the business out prior to settlement and will be responsible for satisfying any debt obligations. These terms can be negotiated, and adjustments may be made to the working capital “True-up” post-close, or in the purchase price if things like equipment loans are assumed, or will be satisfied at, or prior to settlement based on the deal structure.
In an asset deal, the buyer purchases specific assets and liabilities of the target company, rather than acquiring the company as a whole. The main features of an asset deal include:
- Selective Acquisition: The buyer chooses which assets and liabilities they want to acquire from the target company. This may include tangible assets (such as equipment, inventory, and real estate) and intangible assets (such as intellectual property, customer contracts, and brand names).
- Liability Control: The buyer can typically avoid assuming unwanted liabilities of the target company, as they are not automatically transferred. Instead, the buyer negotiates which liabilities they are willing to assume as part of the deal.
- Tax Implications: In an asset deal, the buyer can allocate the purchase price among the acquired assets, which can have tax advantages. The buyer also starts with a new tax basis in the acquired assets. This can have significant tax advantages for a Buyer when it comes to depreciation. In turn, the purchase price allocation can have a negative impact on a Seller. Having a Tax Impact Analysis performed well in advance of closing will give you a good ballpark idea of your tax obligations depending on which deal structure is selected. Having this detail in advance helps in the negotiation phase to ensure that the Seller can be “Made Whole” if a Buyer elects an Asset deal or elects a 338(h)(10) which we will explain in a future article.
- Continuity and Transition: Unlike a stock deal, an asset deal often involves the formation of a new legal entity by the buyer to acquire the assets. The buyer then operates the business using the newly acquired assets, while the seller may continue to exist as a separate entity or wind down its operations. As a result, depending on the type of business and the deal structure agreed to, new contracts may need to be signed with clients, employees may need to be terminated and rehired by the acquiring entity, new benefit plans and insurances may be required, and a host of other obligations may exist depending on your business and agreed upon deal structure. Working with a professional firm focused on M&A consultation will help to ensure you can mitigate your risks, avoid the pitfalls, and maximize the benefit of the deal structure selected in your transaction.
Each type of transaction has its own advantages and considerations, and the choice between a Stock deal and an Asset deal depends on factors such as the goals of the buyer and seller, tax implications, existing liabilities, and regulatory considerations. It is important to consult with legal, tax, and financial advisors to assess the specific circumstances and determine the most suitable structure for a particular sale or acquisition.
The tax implications for the Seller can vary between a Stock deal and an Asset deal. Here’s a general overview of some of the tax considerations associated with each type of transaction:
In a Stock deal, the seller sells their shares in the company to the buyer. The tax implications for the seller in a Stock deal may include:
- Capital Gains Tax: The profit made from selling the shares is generally subject to capital gains tax. The tax rate applied to capital gains depends on several factors, including the seller’s holding period (short-term or long-term) and their individual tax bracket. Deal structure can be critical in this area as some pay-outs or agreements made between the Buyer and Seller may be deemed ordinary income if not structured correctly as part of the deal.
- Basis Adjustment: The Seller’s tax basis in the shares they are selling affects the calculation of capital gains. The tax basis is usually the original purchase price of the shares, adjusted for any previous taxable events, such as dividends or stock splits. Other events or conditions can alter basis, including inheritance or partner buyouts, so be sure to consult with a tax professional prior to making any tax assessments.
- Preferential Tax Rates: Long-term capital gains (assets held for more than one year) may qualify for preferential tax rates, which are generally lower than ordinary income tax rates. However, short-term capital gains are typically taxed at the seller’s ordinary income tax rates.
In an Asset deal, the Seller sells specific assets and possibly liabilities of the company rather than the shares. The tax implications for the Seller in an Asset deal may include:
- Asset Depreciation Recapture: If the assets being sold have been depreciated for tax purposes, a portion of the proceeds may be subject to depreciation recapture tax. This tax recaptures the gain attributable to the depreciation deductions previously claimed by the Seller.
- Ordinary Income vs. Capital Gains: The tax treatment of the sale proceeds from different assets can vary. Generally, gains from the sale of certain types of assets, such as inventory or accounts receivable, are treated as ordinary income. Other assets, such as real estate or goodwill, may qualify for capital gains treatment.
- Allocation of Purchase Price: In an Asset deal, the purchase price is allocated among the assets being sold. The allocation can have tax implications for both the Buyer and the Seller. It is essential to consult tax advisors to ensure that the purchase price allocation is structured appropriately and in compliance with tax regulations. Your M&A advisor will help advise on adjusting the deal structure to ensure the terms of the deal inure to the benefit of both the Seller and the Buyer without significant disadvantage to either party.
It’s important to note that tax laws and regulations can be complex and are subject to change. The specific tax implications for a Seller in a Stock deal or an Asset deal can vary based on factors such as the seller’s jurisdiction, the nature of the assets being sold, and any applicable tax treaties. It is always recommended to consult with tax professionals who can provide personalized advice based on the specific circumstances of your transaction.
The information provided in this article is for general informational purposes only and is not intended to constitute legal, investment, or accounting advice. Summit Advisory is not a licensed attorney or accountant. The content presented should not be considered a substitute for professional advice from a qualified attorney, accountant, or financial advisor. Laws, regulations, and financial practices are subject to change, and individual circumstances may vary. Therefore, it is important to consult with a licensed attorney, accountant, or financial advisor to obtain specific advice tailored to your situation before making any decisions or taking any action.