M&A Tax Planning for Families With Closely Held Businesses

April 1, 2021

Mergers & Acquisitions Part 1—Asset Versus Stock Sales

  • Selling the family business can be a great boon, but beware the tax consequences—asset sales generally favor the buyer
  • How the sale is structured is key, and the right approach can potentially save the seller a lot of money
  • It’s smart to consider the potential structures from the outset if there is an eye on exiting down the road
  • Running Point’s team of professionals is well steeped in the technical nuances of M&A (mergers and acquisitions), tax planning, accounting (many CPAs lack the technical expertise regarding M&A or entity restructure), and financial planning

More and more, single and multigenerational family businesses are finding themselves to be acquisition targets by larger firms. Potential buyers seek either to invest in the business or to add it to their current operating structure as a strategic purchase.  

These types of transactions can create generational wealth for a family. The family may even feel as though they have won the lottery—but in reality, it’s a result of what the family has put into the business—their own time, effort, and dedication.

This article is the first in a series on the subject of merger and acquisition transactions involving a closely held business. In each discussion we will highlight an important concept, starting with the potential tax consequences of the structure of the transaction. Please note that the information here is not meant to be tax advice, but rather a brief overview of general concepts.

This brings us to our topic of discussion today: asset versus stock sales. In order to ensure that the family selling their business receives the greatest possible amount of after-tax consideration (cash and otherwise), the family has to be aware of the general tax consequences of the different types of transactions.

Let’s dive into the types of sales from a tax standpoint and how they ultimately impact what the family takes home when the deal is done.

For tax purposes, the sale of a business generally falls into one of two categories: an asset sale or a stock sale. In an asset sale, as the name suggests, you sell the assets of your business rather than the entity itself (partnerships notwithstanding, but more on this later). In a stock sale, you sell your stock, which is conceptually similar to when you sell stocks in your investment account. From a deal structure standpoint, an asset sale generally has less favorable tax consequences for the seller and more favorable tax consequences for the buyer.

Let’s dive deeper into why that is. In an asset sale, certain assets held by the business can give rise to what is classified as ordinary income, which is taxed at your marginal rate (as high as 37% for federal purposes currently) rather than capital gain rates (as high as 20% for federal purposes currently). Some examples of these assets would be accounts receivable (for cash basis taxpayers) and inventory. The higher tax rate on a portion of the gain means the family walks away with less cash. Depending on your business, this difference could be substantial. Additionally, the gain may be subject to state taxes in the jurisdictions where the company operates rather than the state of residence of the family members, as is typically the case in a stock sale.

Furthermore, the buyer in an asset sale receives the benefit of a “step-up,” which means the buyer will record the assets for tax purposes at their fair market value, rather than their current basis. This allows them to recover their purchase price in the form of special tax deductions over time. This is a huge benefit to the buyer from a time value of money standpoint (that is, the concept that having money now is more valuable than having the same amount later). If the buyer instead bought the stock of the business, they would generally have to wait until they sell the stock to benefit from what they paid for the business.

One important note: If the family’s business is held in a partnership or if it is a limited liability company taxed as partnership, the asset sale treatment is almost inevitable, since for tax purposes selling the equity of a partnership is a de facto asset sale.
If the business is a corporation, a stock sale is a possibility. However, restructures are common in order to allow the buyer to acquire ownership of the entity and still benefit from the aforementioned special tax deductions.

If a family does find itself locked into asset sale treatment, it is not necessarily a catastrophe. In fact, if handled correctly by the family’s advisors, the seller can leverage the buyer’s tax benefits. For example, the parties can agree to split the difference—that results in more after-tax cash for the seller when compared to just agreeing outright to an asset sale.

Keeping with the theme of this discussion, it is also worth noting that if a family is anticipating a sale in the near future, they should look to their tax, accounting, and legal professionals to review their current structure prior to engaging in discussions with interested parties in order to understand their options. Additionally, it goes without saying that structure should be carefully considered when establishing a new business with an eye on exiting down the road.

Overall, families selling their businesses should be aware of the tax ramifications of the structure of their sale. There can be material differences in tax rates—and therefore after-tax dollars—between asset and stock sales. It is important to understand these concepts from the initial phase through close, as it is often the case that the deal structure is outlined in the letter of intent a seller receives from a potential buyer. But with advisors who are well versed in these matters on their side and a general understanding of the concepts, families can make sure they are getting the best deal possible when cashing out on their hard work. This is one of the reasons why the services offered by a multifamily office such as Running Point Capital Advisors are so valuable. Running Point has a team of financial professionals well steeped in the nuances of M&A structuring, tax planning, accounting (many CPAs lack the technical expertise regarding M&A or entity restructure), and financial planning—all working together under the same roof.

For our next topic in the series, we will discuss the steps businesses can take to prepare for an eventual sale and further highlight the unique benefits that a collaborative family office can bring to the process.

Joshua Forrester
Senior Tax Manager

Disclosure: The opinions expressed herein are those of Running Tax and Consulting, LLC (“Running Point”) and are subject to change without notice. Running Point Capital Advisors, LLC is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Running Point Capital Advisors, LLC, including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request. RP-21-07.