As an entrepreneur, your eyes are focused on the right opportunities for mergers and acquisitions. As you evaluate financial risks and gains, regulatory issues and integration strategies, a tax consultant with the knowledge to mitigate tax implications and develop actionable strategies is an integral part of your team. A comprehensive tax strategy, complete with modeling and analysis, will ensure that your transactions go smoothly and that you’ll avoid the following missteps that can quickly and completely derail your deal.
1. Understanding Tax NexusAs the COVID-19 pandemic swept through the country, work habits changed rapidly, highlighting the tax nexus—an issue that was virtually nonexistent three years ago. A tax nexus is the relationship between a state’s taxing authority and a business. It refers to the amount and degree of business activity that must be present before a state can tax an entity’s income or sales within that jurisdiction.
A buyer is purchasing the liabilities and exposures of a company, which makes it imperative to invest the necessary time on tax due diligence. The goal is to find out if the company in question is up-to-date on tax responsibilities in other states, and if it isn’t, to adjust the purchase price for exposure.
2. Implications of Net Operating Losses
Oftentimes, entrepreneurs assume NOLs will carry forward indefinitely. They automatically factor this into their thinking about a deal, but there are circumstances where NOLs may lose their value completely due to the dimension of the ownership change. With more than 50% change in ownership, the value of the NOLs can be compromised, and a company’s financial outlook can shift dramatically.
Code Section 382 must be carefully considered so you can accurately assess the value of NOLs, which directly impact transaction value. Forecasting the benefits of NOLs is an extra layer of due diligence that will shed light on potential benefits or costs, so there are no surprises after a deal closes.
3. R&D Tax Credits
The Tax Cuts and Jobs Act increased the opportunity to use R&D credits to offset income or payroll taxes. Our expertise ensures that you are asking the right questions in the pre-transaction phase to realize the tax benefits in the post-transaction phase.
Documentation is increasingly critical to realizing the economic benefits of R&D credits. When acquiring a business, it is imperative to review the seller’s documentation and ensure that it is sufficiently detailed so the R&D credit is not disallowed. Should a transaction come under IRS scrutiny, those without proper documentation to support the credit may never realize the economic benefit of those credits.
Additionally, unused credits due to QSBS election can be acquired and used by a buyer to offset payroll taxes, post transaction. When negotiating a sale or acquisition of a business, the entirety of these issues will impact the purchase or sale price.
4. S Corp Status
Our advisors have a deep understanding of built-in gains and passive investment income tax that can trigger unanticipated corporate level taxes on S corp transactions.
Built-in gains are gains accrued by a corporation on the date of S corp conversion. At the time of an asset sale, a built-in gains tax may be assessed at the corporate level. Passive investment income tax may be assessed at the highest corporate rate if the company has accumulated earnings and profits from the years it operated as a C corp.
5. Inadvertent Loss of S Corp Status
While most tax-free I.R.C. 368 reorganizations apply to S corps, owners of S corps have to be careful the reorganization doesn’t inadvertently terminate S corp status during the transaction.
Terminating S corp status is a very valuable misstep that can open a business up to corporate level taxation that can be very, very expensive. While many entrepreneurs aren’t aware of how S corp status can negatively affect valuation, our advisors are up-to-date on the IRC and its requirements.
The Importance of Tax Due Diligence in M&A
Identifying a target’s tax liabilities that you may inadvertently inherit as the purchaser is a key to understanding the complete financial picture of any acquisition. Oftentimes, purchasers overlook the fact that tax authorities may go after them for unpaid taxes of the target company. Additionally, many states impose taxes on the transfer of assets, and sales tax may apply to the sale of tangible personal property other than inventory for resale. These taxes may also apply to the conveyance of real property.
A Shared Mindset for Growth—Get in Touch With Us
With a proactive tax partner by your side, you can feel confident that you have a complete picture of the financial viability of any M&A.
For more information on how our entrepreneurial tax advisors can contribute to your success and achievement through leading-edge tax consulting and planning, contact us here or call us at 561.453.1441.
LEGAL OR TAX: The information herein is not legal, such as trust or estate planning, advice, or tax advice. Any such information is provided for illustrative purposes only and must not be relied upon without the benefit of the advice of your lawyer and/or tax professional. Lido specifically disclaims any liability from any reliance on such information. Lido is not a legal service provider or tax professional and does not offer legal or tax advice. Should you desire to obtain tax or legal services or advice, you must enter into your own, independent engagement agreement with a licensed attorney or tax professional.