Tax Considerations in M&A

The intricacies of tax considerations in a merger or acquisition (M&A) transaction cannot be overstated. These considerations play a crucial role in shaping the overall economics and structure of the deal, and can significantly impact the outcome for all parties involved. With expert tax planning and structuring, it is possible to mitigate the tax burden and maximize the benefits of the transaction. In this exclusive interview, Lesley Adamo, Vice Chair of the Tax Group at Lowenstein Sandler LLP, delves into the importance of tax considerations in M&A and provides valuable insights on navigating this complex landscape.

“It is best if a seller has tax advisors involved during the term sheet because some of the terms in there could really be disadvantageous for them and hard to renegotiate later on.” - Lesley Adamo

Tax Complexities

Many complexities are caused by the different tax structures of the parties. Usually, the best structure for one party will almost always be bad for the other. The deal can get complex quickly, so both parties must engage with a tax advisor before negotiating the term sheet. Here are some of the factors that affect taxes greatly:

• The business structure of the buyer and the seller (C Corp, S Corp, LLC)
• The deal structure (cash, equity, earnout)
• Location of the deal (state and local taxes vary)

Buyer’s Considerations

Buyers must understand that their tax structure will depend on their deal rationale. If the transaction is a stock deal, then the buyer is assuming the tax liabilities of the seller. However, if the transaction is an asset deal, then the tax issues will stay on with the seller, except for some state and local taxes. Optimizing the deal’s structure for tax efficiency will save buyers a lot of money. 

Always do extensive diligence. Hire an accounting firm and diligence the entire target company, and then lawyers will look at the big issues and negotiate the tax aspects of the transaction. Also, reps and warranty insurance very rarely cover known tax risks. Try to negotiate indemnification from the seller or get special tax insurance. 

Seller’s Considerations

Since the buyer drafts the term sheet or the LOI, it’s usually the seller that has a problem and needs to negotiate. Most of the terms under the term sheet can put the seller at a disadvantage, so it is imperative that they involve a tax advisor early. Renegotiating them after signing the term sheet will be extremely difficult. 

Here are some general parameters that would be tax efficient for the seller.

• The seller must pay as little aggregate taxes as possible on their sale proceeds.
• The seller must structure the transaction in a way that there’s only one level of tax on the cash.
• There must be deal considerations for the taxes to be long-term capital gains, not ordinary income.
• The seller must avoid paying taxes if they are getting any equity for their equity.

If the seller is a C-corp, the most tax-efficient way is to sell their stocks because there's one level of tax on that sale, and it's usually long-term capital gain. Selling the assets of a C-corp will be very tax inefficient because they will be taxed twice.

To bridge the gap between the two parties, a gross-up is what usually happens. A gross-up is an additional amount of money added to the final price of the transaction to cover the income taxes the seller will owe because of the deal structure the buyer wanted.

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