Stock Purchases: Tax Considerations for the Buyer and Seller
When considering a business acquisition, there is an important distinction between whether the deal is structured as an asset or a stock deal. This blog will explore the key considerations from both the buyer and seller sides in a stock acquisition deal. For information related to asset acquisitions, please refer to our previous Asset Purchases blog.
THE BUYER SIDE
In a stock deal, the buyer purchases the stock of the seller, rather than the seller’s assets (as would be the case in an asset deal). As compared to asset deals, which enable the buyer to avoid assuming the seller’s liabilities, the buyer in a stock deal acquires all the assets and liabilities of the seller. This means that the buyer’s investment is potentially at risk if the seller ends up having liabilities that are not known at the time of acquisition. At the time of acquisition, it is common practice for the buyer to request that the seller disclose any potential liabilities and/or agree to indemnify the seller from any liabilities that may arise after the purchases of the stock.
When the stock of an entity is purchased, the buyer gets a carryover basis in the assets of the purchased entity. The buyer does not own the assets, but rather owns shares in the entity–which means the buyer effectively retains the same basis the seller had in the assets. Therefore, the buyers does not get the additional depreciation that would be available in an asset deal or one with a stepped-up tax basis. There is also no tax-deductible goodwill. It is worth noting, however, that in a stock deal the buyer does acquire the purchased entity’s tax attributes (i.e. net operating losses, capital losses, and credit carryforwards subject to limitations).
From the buyer’s perspective, attaining a step-up in the tax basis of the assets in order to get depreciation deductions is advantageous. If the stock was purchased from the seller, the buyer can treat the transaction as if it were an asset purchase for tax purposes if the seller and buyer agree to make one of two elections: either a section 338(h)(10) or a 336(e) election. The differences between the two elections are as follows:
• 338(h)(10) Election:
– Seller must be a subsidiary member of a consolidated group or the shareholders of an S corporation
– Purchaser must be a single corporation
• 336(e) Election:
– Seller must be a domestic corporation or shareholders of an S Corporation that make a qualified stock disposition
– Purchaser does not have to be a corporation
Structuring the stock deal as an asset purchase avoids the requirement to actually transfer the titles of the seller’s assets to the buyer and pay the associated transfer taxes. This allows the buyer to lower the legal and administrative costs associated with an asset purchase agreement but retain the favorable tax treatment of an asset deal.
THE SELLER SIDE
From the seller’s perspective, if the transaction is not taxable to the seller such as in a qualifying corporate reorganization, the tax basis in the asset is carried over to the buyer.
If cash is exchanged for shares, the seller will have taxable income if the seller realizes gain. One way for the seller to offset the gain on the sale of the stock or gain on the deemed sale of the assets if a section 338(h)(10) or section 336(e) election is made is to utilize the tax attributes of other members of the consolidated group. Alternatively, the buyer can exchange its shares for the seller’s shares in a qualifying corporate reorganization, which would allow the seller to avoid immediate taxation on the exchange.
When determining whether to structure a transaction as a stock versus an asset deal, the associated costs tied to each type of deal are a central component to keep in mind. Executing a stock deal is typically less expensive than an asset deal, since the transferring of assets is a lengthy process. In addition to the costs incurred by the business transaction, the decision to model a deal as either an asset or stock purchase comes with a laundry list of potential tax implications, advantages and disadvantages, all dependent on the details of each specific scenario.
Our professionals at FF&F are familiar with the questions you should be asking yourself before moving forward with any transaction, and we are well-equipped to assist you throughout each step of the process. For questions about asset purchases, general business transactions, or for information about our services, please contact us at firstname.lastname@example.org or (212) 245-5900.
Kimberly Roque, CPA, MST is a Tax Manager at FF&F with over 9 years of accounting experience, with 6 in private and 3 in public accounting. Her focus is consolidated corporate tax returns and income tax provisions.