Tax Issues in Business Acquisitions
When a business is acquired through the purchase of stock or assets, it raises several tax-related issues. The purchase price must be allocated among the assets acquired, and this allocation has significant tax consequences for both the seller and acquirer. The purchase price consists of consideration paid, liabilities assumed, and acquisition costs. The residual method is used to allocate the purchase price among the assets acquired, and the allocation is reported to the IRS on Form 8594 (The CPA Journal Archive, n.d.).
Assets are categorized in a seven-class system: cash, actively traded personal property, debt instruments, inventory, and more. Acquisition costs are added to the basis of assets acquired and should not exceed the fair value of the assets. Liabilities that have not matured as of the purchase date are treated as consideration paid for the assets and are added to the basis. Contingent liabilities are uncertain and may be treated as a liability of the seller or buyer.
Impact on Amortization and Tax Strategies
In addition, the allocated purchase price also affects the amortization of the assets, with some assets having a shorter amortization period than others. The fair value of the assets should also be considered when determining the allocation of the purchase price (The CPA Journal Archive, n.d.). The seller and acquirer may have different tax strategies and goals, and the allocation of the purchase price can significantly impact their respective tax liabilities. Both parties need to consult with a tax professional to understand the potential tax implications of the allocation. The allocation of purchase price also needs to be consistent with the actual transfer of ownership and the economic substance of the transaction.
Accounting Treatment and Reporting Requirements
Another essential aspect to consider when allocating the purchase price is the impact it may have on the accounting treatment of the transaction. The purchase price allocation to different assets may affect the financial statements and the financial performance of the acquirer and the seller (The CPA Journal Archive, n.d.). Furthermore, the allocation must be done by the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) to ensure that the financial statements are accurate and reliable (The CPA Journal Archive, n.d.).
Additionally, it is essential to note that the purchase price allocation is not just a tax-driven decision. Still, it has legal and commercial implications that must be considered. It can also affect the business’s future transactions, such as mergers, acquisitions, or divestitures. Finally, it should be noted that the IRS may review the purchase price allocation, and the parties should have proper documentation and justifications to support their allocation.
It is important to note that the purchase price allocation is a complex process that requires a thorough understanding of the tax laws and regulations. It is advisable to consult with a tax professional or a financial advisor to ensure the purchase price allocation correctly complies with the regulations (Arnold et al., 2019). When a company that has been acquired reduces its workforce, it may provide severance payments to employees who have been terminated, as per agreements made with the previous owner of the business.
Tax Treatment of Severance Payments After Acquisition
How taxes are applied to severance payments given to employees who were let go before or after a company is purchased is different. According to a ruling by the IRS (Revenue Ruling 94-77), severance payments made as part of a downsizing plan are considered tax-deductible, even if the company benefits from the downsizing by having lower payroll costs. In another case (TAM 9721002), the IRS allowed the deduction of severance costs incurred after a company was acquired, when employees were let go two days after the acquisition (The CPA Journal Archive, n.d.).
In this case, the new company owners decided to let go of a group of senior executives and cut several salaried jobs. The employees who were let go were entitled to severance benefits, based on agreements they had made with the company before it was acquired. The IRS determined that the severance payments were not related to the acquisition.
Tax Treatment of Start-Up and Acquisition Costs
Expenses incurred before a business generates revenue can’t be written off as a tax deduction. They can be written off over 60 months if the business chooses to do so. Start-up costs include expenses incurred concerning the investigation, creation, or acquisition of an active trade or business (The CPA Journal Archive, n.d.).
Due diligence costs incurred before a decision to purchase are considered start-up costs. Still, after a decision to purchase, they are considered acquisition costs and must be allocated to the assets purchased. This applies to expenses that can be written off under section 162 of the Internal Revenue Code and does not apply to interest, taxes, or research and development expenses.
Deductibility of Due Diligence and Expansion Costs
Expenses incurred during the investigation and due diligence of purchasing a business are considered deductible as expansion costs if the purchaser is already in that business. Still, they are considered start-up costs if the purchaser is not in the same business. The term “final decision” is unclear (The CPA Journal Archive, n.d.). According to Revenue Ruling 99-23 by the IRS, the point at which a final decision on a new business venture is made is when both parties are legally bound to each other. Therefore, expenses incurred while deciding to enter a new business or which business to enter are considered start-up costs.
Industry-Specific Tax Implications for Business Purchases
Regarding the tax treatment of expenses related to buying a business, the distinction lies in whether the buyer is already in that line of work. If they are, research expenses and examining the potential purchase are considered deductible as expansion costs. However, those costs are considered start-up expenses if the buyer is not in the same industry. Notably, when the buyer is not already in the same business, expenses can only be considered investigatory costs if incurred before the final decision to acquire the business (The CPA Journal Archive, n.d.).
The court has allowed for the deduction of costs related to expanding the business and developing new markets for wholesale customers. It is essential to consult with a tax professional to ensure that the expenses are classified correctly and avoid potential tax issues. It is also important to note that the tax treatment of severance payments and start-up expenses can vary depending on the specific circumstances of the transaction and the laws in the jurisdiction where the business is located.
References
Arnold, B. J., Ault, H. J., & Cooper, G. (2019). Comparative income taxation: A structural analysis.
The CPA Journal Archive. (n.d.). Tax issues arising with IRC section 338(h)(10) acquisitions. Web.