MACNY. Tax Implications of a Business Transaction. May 10, 2017

Transcription

1 MACNY Tax Implications of a Business Transaction May 10, 2017

2 Thomas J. Giufre Fust Charles Chambers LLP

3 Review of the Different Types of Entities C Corporation: Entity level taxation Two levels of taxation with one at the corporate level and one at the shareholder level (dividends and upon liquidation)

4 Review of Different Types of Entities S Corporation: Typically not a taxpaying entity Items of income, deduction and credit flow through to the shareholder and are reported individually on their tax return Generally a single level of taxation. The shareholder s basis increases by the pass-through income and other taxable items. Distributions are received tax free to the extent of available basis Certain requirements do not always make being an S corporation the ideal choice 100 Shareholder limit Only a single class of stock is allowed, however voting rights may be different Shareholders are limited to individuals, estates, certain trusts and tax exempt organizations

5 Review of Different Types of Entities Limited Liability Companies (LLC): Typically taxed as a partnership for federal tax purposes, but can be taxed as a C corporation Taxation is very similar to an S corporation Less restrictive than an S corporation. No restrictions on who can be owners and more flexibility in its allocations to partners Members outside basis includes their share of the liabilities of the LLC. This does not occur for an S corporation

6 Asset Purchase Agreements and Stock Purchase Agreements What are the considerations and preferences? Sellers typically want to sell stock, especially in a C corporation, because of the tax on any built in gains that will occur. An asset sale and stock sale may not be tremendously different for an S corporation or a partnership Buyers typically want to buy assets. An asset purchase provides a stepped up basis to fair market value allowing for potential depreciation and amortization as opposed to a carryover basis. Buyer is generally motivated to buy assets of a C or S corporation. Partnerships bring a different perspective because of Section 754 elections We will examine the advantages and disadvantages of both by entity type

7 C Corporations Stock Sale/Acquisition Gives rise to only one level of tax payable at the shareholder level. Gain is recognized as the difference between the money and FMV of property received less the adjusted basis in the stock For the seller of C Corporation Stock, if it is owned longer than one year it is long term capital gain (preferential tax rates). If there is a note issued as part of the payment, typically the installment method can be used to recognize the gain. Electing installment method treatment is automatic Escrows are often used. If there are substantial restrictions on receiving the payment, the amount is included as part of the installment funds The tax attributes of the corporation (NOL s etc.) generally continue to be available to the buyer, but there are limitations (SRLY rules)

8 C Corporations, Continued Asset Sale/Acquisition A C corporation shareholder selling their investment will prefer the stock purchase instead of an asset purchase. The asset sale will bring two layers of tax. One a the corporate level on the sale of assets and again at the shareholder level upon liquidation The gain is taxed at ordinary C corporation tax rates (no lower capital gain tax rates). When the company liquidates, the proceeds distributed to the shareholders will be taxed again as a dividend

9 C Corporations, Continued Sale of qualified Small Business Stock (QSB) Non-corporate taxpayers can exclude from gross income a percentage of the gain from the sale of QSB stock A QSB is a small business (less than $50 million in assets) and original issue stock Does not include service industries Gain exclusion can be anywhere from 50% to 100% with separate computations for Alternative Minimum Tax There is a 5 year holding requirement The gain exclusion is subject to a cap that is the greater of (1) 10 times the basis in the QSB stock or (2) $10 million

10 S Corporations The subchapter C rules apply to an S corporation, so the same types of sales can take place, which include a stock sale and an asset sale. The sale/purchase of an S corporation can also be structured as a stock sale, but taxed as an asset sale under IRC Section 338(h)(10) When there are appreciated assets, the buyer usually prefers to buy assets (for the step up) The S corporation shareholders may be indifferent to a stock sale versus an asset sale, because of the pass-through nature. There could potentially be ordinary income components from the gain such as depreciation recapture or Built in Gains Tax

11 S Corporations, Continued S Corporation Stock Sale Much like a C corporation, gain is recognized by the shareholder as the difference between fair market value of property received less the basis in the stock Basis is affected in the year of the sale by the reporting of pass through income/loss. The default allocation is on a per share/per day basis. The shareholders can elect to terminate (close) the tax year Preferential capital gains tax rates depend on the length of time the stock is held Any suspended losses due to basis limitations may expire permanently unused

12 S Corporations, Continued S Corporation Asset Sale An asset sale with liquidation will usually have the same result as the stock sale, except for depreciation recapture that may be passed through and Built in Gains tax that may be recognized. The pass-through income and gains increases basis. The distribution of the proceeds will decrease basis

13 S Corporations, Continued Stock Sale with Section 338(h)(10) Election Buyer wants the benefits of an asset sale, but for different reasons it cannot be structured Requires a qualified stock purchase (QSP) (80% or more of the stock purchased by another corporation) The stock purchase is ignored for tax purposes, instead the target corporation generally is treated as making a deemed sale of its assets and then liquidating. The tax treatment to the target shareholders generally is consistent with sale and liquidation treatment

14 Partnerships Transactions can take on many forms. Partners can sell their interests to a buyer, partners can liquidate their interests, effectively selling to the remaining partners of the partnership. They can sell assets and distribute the proceeds in liquidation. If 50% or more of a partnership s interests are sold within a 12 month period the partnership terminates under IRC Section 708

15 Partnerships, Continued Sale of a Partnership Interest Selling Partner Generally treated as a capital asset. Recognize gain or loss equal to the difference between the amount realized on the transfer and the adjusted basis in the partnership interest. Gain or loss is generally capital in nature The portion of the partner s interest in unrealized receivables and substantially appreciated inventory (hot assets) are not considered a capital asset. IRC Section 751 Unrealized receivables include items such as cash basis receivables. The other common items falling into this category are ordinary income recapture for depreciable assets under IRC Section 1245 and 1250 Inventory items are considered substantially appreciated if their FMV exceeds 120% of their adjusted basis in the partnership

16 Partnerships, Continued Sale of a Partnership Interest Selling Partner, Continued The amount treated as ordinary income on the sale or exchange of an interest is determined by assuming a hypothetical sale of all of the partnerships hot assets in a fully taxable transaction immediately before the transfer of the partnership interest

17 Partnerships, Continued Sale of a Partnership Interest Buying Partner A partnership s basis in its property is commonly referred to as inside basis. A partner s basis in its partnership interest is referred to as outside basis. How these two interact depends on whether the partnership has a Section 754 election in place. The Section 754 election permits the partnership to adjust the basis of partnership property on transfers of partnership interest (IRC Section 743) and distributions to partners (IRC Section 734). In the case of the transfer of interest, the adjustment is the difference between the partners outside basis and his/her share of inside basis of partnership property If there is no Section 754 election in place, the basis of the partnership assets allocable to the buying partner will carry over from the selling partner (inherit the seller s inside basis)

18 Partnerships, Continued Liquidation of a Partner s Interest (Redemption) Liquidating Partner The result may be very similar to the sale of a partnership interest. However, it may be very different because there is the ability for payments to be treated as either a distributive share of partnership income, a guaranteed payment or a liquidating distribution

19 Partnerships, Continued Liquidation of a Partner s Interest (Redemption) Treatment to the Partnership (No Section 754 in Effect) Distributions of partnership property to partners in liquidation do not affect the inside basis of the remaining property held by the partnership. If there is no Section 754 election, there is no adjustment to the inside basis of property (Section 754 in Effect) IRC Section 734 requires the partnership to adjust the partnership property to reflect gains or losses recognized by the distributee partner

20 Partnerships, Continued Partnership Asset Sale Very similar to an asset sale for an S corporation. At the time of the sale, items of income, gain, loss and deduction will be passed through to the partners. The sale of partnership assets may give rise to depreciation recapture. The income and gains will increase partner basis. Distributions (perhaps of proceeds from the sale of assets) will decrease that partner basis

21 Questions