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Advanced Mergers & Acquisitions

October 8, 2015

Tom Schnellenberger Ice Miller LLP

One American Square Indianapolis, Indiana 46204

Telephone: (317) 236-5886 (direct) E-mail: [email protected]


Tax Considerations

“It’s not what you make; it’s what you keep...”


Corporate Law

Sole proprietorship

Partnership • GP • LP • LLP • LLLP

LLC

Corporation

Entity Classifications

Tax*

“Disregarded entity” (e.g., Form 1040 Schedule C) • Single member LLC • Q Sub

Partnership (Form 1065) • GP • LP • LLP • LLLP • Multiple member LLC

C Corporation (Form 1120) S Corporation (Form 1120S)

* Chart reflects “default” tax classifications; generally, most entities can elect to be treated as a corporation for tax purposes.


“Tax Tension” Between Buyers & Sellers

Buyers want: Basis step-up

To pay as little cash as possible

To avoid hidden liabilities

To inherit favorable attributes (NOLs, credit carry forwards)

Sellers want: To conserve cash (pay as

little tax as possible)

To avoid contingent liabilities

To avoid winding up headaches


“Tax Tension” Between Buyers & Sellers (Cont.)

Buyers want: To Buy Assets

Sellers want: To Sell Stock


Shareholders

Buyer

C Corporation

Cash

Stock

Seller – Capital Gains

Buyer – Basis in Stock

C Corporation Stock Purchase


Shareholders

Buyer C Corporation

Cash

Assets

Seller – See next page

Buyer – Step up in basis more depreciation/amortization

C Corporation Asset Purchase


Tax on C Corporation Sale of Assets Corporate Tax Cash

Sales price of assets Basis in assets Taxable income

$1,000 10 990

$1,000

Tax rate Tax

x 40% 396

(396)

Shareholder

Liquidation cash Basis in stock Gain on liquidation Tax rate Tax Net cash

$ 604 10 594 22% 131

(131) $ 473


Tax on C Corporation Sale of Stock

$1,000 $1,000 10 Basis in stock

990 Taxable gain

(218) $ 782

22% 218

Individual rate* Individual tax Net cash *Assumes long-term capital gain treatment

Cash Sale

... an increase in cash to the shareholders of $309!!

Sales price of stock


Members/Partners

Buyer

Because of Section 754/743 elections generally (but see anti-churning discussion later) does not matter whether selling assets or interests. But both subject to recapture (ordinary income treatment).

Partnership/LLC

Interest

Interest

Partnership Acquisition


Section 754/743 Election Simplified

Buyer gets step up = seller gain. Step up allocated based on underlying asset appreciation and amortized/depreciated by buyer.

Partnership/LLC

Buyer


Shareholders

Buyer

S Corporation

Cash

Assets

Buyer – Step up in basis. Seller – One layer of tax unless Section 1374 built-in gains/tax applies. Also, recapture and rollover issues.

S Corporation Asset Purchase


Shareholders

Buyer S Corporation

Cash

Stock

Buyer – Capital gain unless Section 338(h)(10) or 336(e) election made then may have recapture (more later). Also, beware of Section 1374 built in gain and rollover issue.

Seller – Can get step up in asset basis if a Section 388(h)(10) or 336(e) election made.

S Corporation Stock Purchase


Shareholders

S Corporation

80% or more of shares

Cash

• If elected treated as 100% asset sale. (Note: Non-selling shareholders subject to tax.)

• Buyer gets step-up in basis of assets.

Corporate Acquirer

IRC Section 338(h)(10)


Shareholders

S Corporation

80% or more of shares

Cash

• If elected treated as 100% asset sale. (Note: Non-selling shareholders subject to tax.)

• Buyer gets step-up in basis of assets.

Non-Corporate Acquirer

IRC Section 336(e)


Section 1060 requires that the parties agree

to an allocation of the purchase price. Form 8594* used to report the purchase price allocation.

Purchase Price Allocation

* Form 8883 used if a Section 338(h)(10) made.


Maximum Income Tax Rates

Corporate Individual*

* May also be subject to Net Investment Income Tax of 3.8%

Ordinary Income 39.6% 35% (

Unrecaptured gain on real estate 25% 35% Collectibles 28% 35% Long-Term Capital Gain 20% 35%

(Including depreciation/amortization recapture


Why Do Private Equity Funds Use Corporate Blockers?

PE Fund

ECI (Effectively Connected Income)

LLC

Income

UBTI (Unrelated Business Taxable Income)

Tax-Exempt Foreign Investors


Why Do Private Equity Funds Use Corporate Blockers? (Cont.)

PE Fund

Dividend

Tax-Exempt Foreign Investors

C Corporation

No UBTI No ECI


Rollover Equity


How NOT to do it!

PE Fund Shareholders

S Corporation

Corporation

Cash

Shares


How NOT to do it! (Cont.)

Shareholders

Corporation

Cash

Shares

Former S Corporation


Shareholder

S Corporation

Cash

70% of stock

Rollover Equity

PE Fund


Shareholder

C Corporation

30% 70%

Rollover Equity

PE Fund


Holding Company • Makes S-Corporation Election

Holding Company Stock

Rollover Equity Flow Through Alternative

Shareholder

Target • Qsub election

Stock of Target

100%


Holding Company S-Corporation


Shareholder

100%

Target LLC Target Qsub

Conversion


Holding Company (S-Corporation)

Ownership


C Corporation

Cash

Target LLC

Shareholder

Cash

* Treated as a sale of assets – Pay attention to IRC Section 704(c) allocation election

PE Fund


Rollover Equity

IRC Section 197(f)(9) Anti-churning rule. • Applies to intangibles owned before August 10, 1993 if own

more than 20% of entity.



Cash

Rollover Equity Section 754/743 Step Up Exception

Shareholder

99% Interest

Newco LLC

1% Interest



Rollover Equity

C Corporation

39% Common Interest Target LLC

Shareholder PE Fund

1% Interest

60% Interest

Cash

Section 754/743



Rollover Equity

C Corporation

39% Interest Target LLC

Shareholder PE Fund

1% Interest

60% Interest Entitled to Section 754/743 step up and amortization


S-Corporation

Issues with Non Pro-Rata Rollovers

Shareholder 1 Shareholder 2

80% Wants to Cash Out 20% Wants to Rollover


S-Corporation Buyer

LLC

Shareholder 1

80%

Shareholder 2

Cash

Cash Dividend 20%

Cash Dividend

Cash Redemption

Cash

80%

Issues with Non Pro-Rata Rollovers (Cont.)

• Gain allocated pro rata

80% Interest in LLC


Options IRC Section 424


Questions?

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