To complement the earlier CPE Day segment regarding key considerations for buying a business, Don Johnston, Mark Wolstoncroft, and Ryan Fronius presented The Price is Right – Issues Related to Selling a Business to explore the audit and tax implications on the sell side of the transaction. (click here for the buy-side recap)
M&A deals can take the form of stock sales or asset sales, though GAAP accounting remains the same in both scenarios. Regardless of the structure, accurately capturing the transaction on the company’s financial statements is a primary concern from an audit perspective. Mark Wolstoncroft started off by delving into key areas that require due diligence. He emphasized that the valuation of items on a company’s balance sheet is a fundamental determinant of the purchase price. Accurate record-keeping and timely appraisals, if necessary, are advantageous to this calculation. He noted that companies must also keep in mind that transaction costs are expensed for book purposes and will show up on the profit and loss statement. The purchase price and transaction costs affect the amount of goodwill or gain on bargain purchase recorded for the transaction. Occasionally, other elements, such as contingent consideration, come into play and must be factored into the purchase price.
Business sales tend to draw eyes to companies’ financial statements. Achieving accuracy through the various complicating factors and uniqueness of surrounding circumstances in these transactions is in the best interest of all parties involved. Mark emphasized the importance of working with an accounting firm on these matters sooner rather than later, specifically three to five years in advance. This advance planning allows ample time for getting the books in good shape, yielding a more accurate valuation of the company, a less stressful selling process, and a more favorable outcome for both the seller and the buyer.
The focus of the presentation then moved to important factors to consider from a tax standpoint when selling a business, including differences between stock (equity) sales and asset sales. Unlike in the GAAP realm, stock sales and asset sales are distinct in their tax implications and differ in the advantages offered to the seller. A stock sale only entails a single level of tax that is subject to more favorable capital gains rates. An asset sale can result in two levels of tax if the entity is a corporation, as well as ordinary income depending on the type of assets sold. Stock sales and asset sales also differ in the determination of purchase price, liabilities assumed, transfer of contracts and agreements, and reporting requirements in the year of and years subsequent to the sale.
Ryan noted that it is possible for M&A transactions to take on a hybrid structure for tax purposes. For instance, in certain situations a seller may elect to treat the sale of their stock as an asset sale for tax purposes, though the transaction legally remains a stock sale. The tax consequences also depend on the type of entity being sold. For example, the sale of an LLC taxed as a corporation will be treated differently than the sale of an LLC taxed as a partnership. All of these variations in tax treatment require increased planning and diligence in structuring the sale. Trusted advisors should be enlisted to help navigate these decisions.
Taking advantage of various tax provisions and strategies can lead to more favorable results for the seller of an entity. Don and Ryan reviewed some of these key tax considerations from the sell side. The timing of a sale can have major tax implications. The timing of liquidation, for example, should be planned in a way that maximizes the amount of any losses from liquidation that may be used to offset other gains and avoid subjecting the losses to certain loss limitation rules. A type of restructuring known as an F-reorganization can also help optimize the outcome of a sale, primarily for corporations. In a typically tax-free reorganization, a new entity is formed that qualifies for more favorable tax treatment. The substance, or end goal, of the transaction ultimately remains the same, while the change in form minimizes the tax consequences. For stock sales, Section 1202 and Section 1244 offer additional opportunities for savings in the event of gains and losses on the sale of certain qualified small business stock.
Companies are susceptible to surprises related to the tax implications of M&A transactions due to the vast and ever-changing tax code, especially in dealing with the varying state tax laws. It is critical that the deal team work with a trusted team of accountants to ensure that nonresident state tax liabilities are considered before distributing cash to owners. By doing so, sellers can avoid over distributing cash that should remain in the business to cover the state taxes on behalf of nonresident owners. Awareness of all reporting requirements is also essential to avoid unwanted surprises.
The goals of business owners can vary from transaction to transaction. Attaining the most favorable outcome in a business sale is often a matter of working with a team of skilled and trusted advisors. Being aware of the rules, advantages, and disadvantages for both financial reporting and tax purposes can seem overwhelming, but working with a skilled deal team early on is a simple but worthwhile strategy to successfully sell a business.
Click here to access copies of the slides, links to resources and a video of the presentation
About GYF’s CPE Day: The firm presents this program each year to bring together clients, friends of the firm, and other professionals who are interested in gaining knowledge. The day is always filled with interesting presentations and great networking opportunities, and is generally attended by 300+ guests. If you have any questions about the material covered, or other issues we did not have time to address, please reach out to your GYF Executive or contact the office at 412-338-9300. We look forward to seeing everyone next year!
