What are Transaction Income Taxes? How are Tax Strategies developed?
Transaction Taxes
Sale of Business Equities
Ownership of a business is an income-producing, or Capital asset. The disposition of a Capital asset is subject to Capital Gain or Loss treatment.
Sale of Business Assets
The sale of a business is considered to be a bulk disposal of multiple classes of assets. They can be subject to both Ordinary and Capital Gain and Loss treatments. The Buyer and Seller are each obligated to file an Asset Acquisition Statement on their next returns that allocate the income from the sale into these categories.
Non-compete Agreements
Income received as consideration to not compete is subject to federal income tax but not federal self-employment tax.
The Transaction Tax Radio Metaphor
Taxes Due = Σ (Tax Rate * Income Realized) for each tax category
Developing a tax strategy is like operating a radio, you don’t need to be an engineer. You just need to understand how the channel and volume controls work. However, you will need to be an engineer to design a radio.
With Transition Tax strategies, the Tax Rates are like the channel control and the Income Realized is like the volume. A Transition Tax specialist can work on your team to design potential strategies, and the M&A Adsvisor can then operate them during negotiations.
Working with your Tax Strategist
Tax Return - Financial Statements Reconciliations
Team Interviews
Seller Due Diligence
Negotiations and Deal Terms
Tax Return - Financial Statements Reconciliations
- Scenario: A business broker is in discussions with the owner of a manufacturing company. The incomes reported on the P&Ls are much different that that on the tax returns.
- Role of Tax Specialist: The tax specialist analyzes those returns and financial statements to find the areas of the tax code causing the differences and reports them to the broker, along with how they impact cash flow.
- Outcome: With a deeper understanding of the actual business cash flows, the broker is able to present an accurate and insightful marketing proposal to win the engagement.
Team Interviews
- Scenario: A business broker is negotiating with a technology startup. The owners are very savvy and wanting detailed answers to their questions now.
- Role of Tax Specialist: The tax specialist joins the deal team in initial interviews to develop the client’s confidence that the tax implications of possible deal arrangements are understood enough to protect the client’s interests and mitigate taxes.
- Outcome: The broker, with the tax specialist on the deal team, gains the trust of the owners and secures an engagement.
Seller Due Diligence
- Scenario: A business broker is representing a recent widow selling the family-owned business. The tax returns she presents cannot be reconciled to the financial statements.
- Role of Tax Specialist: The tax specialist conducts a thorough review, uncovering significant tax underreporting liabilities. The specialist makes arrangements for a new tax preparer to reconstruct the financial reports and prepare ongoing tax returns.
- Outcome: The proactive approach of the tax specialist allows the broker to disclose the problem and enable the widow to both address her tax issues and have the financial documents needed to sell the business. The widow is also now in a better position for Innocent Spouse relief from her late husband’s liabilities should the need arise.
Negotiations and Deal Terms
- Scenario: A business broker is negotiating with a private equity firm interested in acquiring a mid-sized manufacturing company they represent.
- Role of Tax Specialist: The tax specialist advises on tax implications of the proposed deal terms, which included the seller receiving a percentage of the new business.
- Outcome: The broker, with the input of the tax specialist, negotiates favorable terms that use a tax free reorganization that avoids the seller owing tax for this year on the percentage of the new business that was part of the deal.