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One of the biggest concerns for a business buyer or seller can be the tax repercussions that occur as a result of selling a business, because this can dramatically alter the amount of capital involved in the M&A transaction. Whether the buyer or seller is the one who must pay the price, the income tax of a business sale can be a substantial amount and therefore effects both parties. It is within one's best interest to utilize whatever legal means possible to lower the heavy tax consequences of a sale.
One way that taxes may be avoided altogether when selling a business is through a tax-free reorganization. This type of acquisition is not considered a sale, and therefore is not be taxed as such. In order to complete a tax-free reorganization, however, a least half of the payout price must be delivered in the form of stock rather than capital. Being paid in stock helps the seller avoid the income taxes that accompany the process of selling a business entity or assets. One must also prove that this restructuring has been implemented for an explicit business objective, rather than a mere avoidance of taxes.
Depending on the type of transaction, the portion of the stock necessary to complete a tax-free reorganization will vary. An "A" Reorganization is considered a stock-for-assets exchange and is the most flexible choice. An "A" Reorganization allows for at least half of the company to be exchanged for cash, while the rest remains with the shareholders. The gain of a cash exchange must also be recognized for the shareholders. The business will be liquidated and all liabilities transferred to the acquirer.
In a stock-for-stock "B" Reorganization, at least 80% of the entity's stock must be transferred to the buyer, with no more than a 20% cash payment. The downside for the seller choosing a "B" Reorganization is that they must accept a majority of the payment in stocks. However, it does allow the business in question to continue operation as a subsidiary of the acquirer.
The purpose of choosing a "C" Reorganization would be so that the acquirer may decide which assets and liabilities to assume under the reorganization. However, as with a "B" Reorganization, the acquirer must exchange their voting stock for target stock. A "C" Reorganization is another stock-for-assets procedure.
It is important to note that a "tax-free" reorganization does not always mean that no taxes will be involved in the consideration. Taxes on stock acquired by target shareholders is simply deferred, not eradicated altogether.
A tax-free reorganization should not be attempted without the assistance of a professional, because it is important to stay within legalities and revenue rulings when processing this type of transaction. Furthermore, if the correct steps are not taken in order to allow the transaction type to fall under the IRS category of a tax-free reorganization, then the resulting tax implications could be even higher. If you are considering a tax-free reorganization, feel free to contact the M&A intermediaries at George & Company. We would be happy to help you make the best business decision for your head and your wallet.