With my personal experience in a CPA firm, I never really thought about corporate structures of
corporations or businesses that would need an extensive tax team. Honestly, most of our clients
have a controller or a CFO if they are larger, but I have not dived into their corporate structure to
see who is employed and why. But recently, we have had one of our larger company’s acquire
another smaller company and incorporate with their company. During these meetings I understood
how many individuals this company had working for them and all the different positions and
duties these individuals had. This was the first client I thought of when I read this prompt of this
discussion post.
I decided to research acquisitions (Type B reorganization) to determine why it is important to hire
adequate staff. Type B reorganization: the acquisition by one corporation of the stock of another
corporation, in exchange solely for all or a part of its own or its parent’s voting stock, if the
acquiring corporation has control of the other corporation immediately after the acquisition,
whether or not it had control before the acquisition (Reg. Section 1.362-2(c)) (CCH Publications
2023).
A company that is having this type of acquisition does not only need their CPA, controller, and
CFO on board, but they also need their legal and political team and their key management. It is
important to have all these individuals in the process to make sure you are making an informed and
logical decision. The board of directors making these large acquisition decisions need to be sure
they have all the information they need, someone to perform a valuation of the company, someone
to interpret the valuation, someone to provide tax analysis, someone to look at legal issues and
make sure all documents are correct, etc. It is so important to hire and maintain adequate tax staff
to ensure that calculations are being done correctly. For example, you want to have intelligent tax
staff that know the current tax laws and how to interpret them. The staff also needs to be able to
make accurate and reliable estimates and calculations of such an acquisition. And lastly, the staff
needs to be able to prepare returns and federal and state documents correctly.
In the example of a Type B reorganization, the tax planning of a business acquisition is crucial. So
much planning must go into acquiring another company. You must get information from the
company you are acquiring, such as the last three years of tax returns, financial statements,
software records, etc. and compare them to ensure the information you are using for the value of
the company is accurate. You need staff that can accurately take that information and verify its
integrity. Once you have determined that information is correct and reliable then you must
determine the value of that company (there are companies that can do this for you, but we always
do one for our clients so they can compare). A company must also ensure they can afford to
purchase the company and come up with a payment strategy which will require competent staff.
These are some of the key components that need to be looked at when acquiring a new company
and tax planning can happen once these have been identified. For example, the company can plan
and prepare projections for tax based on the acquisition to see how it will affect their bottom line
and their tax returns. The company may want to know how much tax it will have to pay or how
much income it can distribute to partners/members. Projections can be compared with data
provided by the company to be acquired and a preliminary decision can be made on whether to put
the time and work into analysing the acquisition.
"Corporation B has a market value of $1,000,000 and Net Operating Loss carry-forward of
$5,000,000. The net operating loss of $5,000,000 will reduce Corporation A’s tax liability by
$1,050,000 (21% of $5 million) thereby making this effectively a free deal. Corporation A’s CEO
is quite excited about this and has a few options:
A. meet with the board of directors on Friday to obtain approval for the deal
B. ask the CFO to identify other acquisition prospects that have similar tax attributes
C. seek the advice of the company’s tax advisers
D. fire the CFO
What do you recommend and why?"
This example forms a tricky scenario. It sounds great, but unfortunately for Corp. A's CEO, I do
not think this would fly with the IRS. This sounds like it would fall under the scope of IRS Sec
269: Acquisitions to evade or avoid tax. The primary purpose of this acquisition is to use the
NOLs to the benefit of Corp. A to avoid paying tax. As written, "Sec. 269(a) provides that any tax
benefit, such as a deduction, credit, or other allowance, may be disallowed if it is obtained by a
person or corporation acquiring control of another corporation with the principal purpose of
avoiding or evading federal income tax" (Knight & Knight, 2021). The IRS would not be too fond
of this transaction and would very likely challenge it and even disallow the losses. As far as the
options provided above: I feel a medley of these is the option. The CEO should hold a meeting
with their board (Option A) to dissect every aspect of this proposed transaction to fully understand
the risk and repercussions that would likely occur. Maybe discuss the future of this CFO's
employment (Option D) because as the CFO of the company, they should be well versed in
financial law or at the very least get some education from the company's tax advisers (Option C),
who would very likely strongly recommend to not go that route.
Overall, tax planning is a huge part of any acquisition or merger. A corporation should be well-
informed on the tax laws regarding these transactions and can plan for the tax consequences
accordingly. There are certain scenarios that provide tax free mergers and acquisitions under IRC
Sec. 368. There are four main conditions that are required to qualify for this:
1. Continuity of interest - proprietary interest belongs to the same person(s) before and after
the transaction occurs
2. Continuity of enterprise - must continue the acquired business as it was or use the majority
of business assets
3. Valid purpose - to summarize, the purpose cannot be for tax avoidance or evasion
4. Step-transaction - "the transaction cannot be part of a larger plan that, taken in its entirety,
would constitute a taxable acquisition" (Ching, 2021).
So based on these conditions, the transaction proposed in the example above would not qualify
under Sec. 368 as a non-taxable acquisition as it serves no purpose other than avoiding Corp. A's
large tax bill.
References:
Ching, Lynn (2021, June 10). TAX FREE MERGERS AND ACQUISITIONS UNDER IRC 368
WHAT WORKED AND WHAT DIDN’T. SF Tax Counsel. Retrieved on July 13, 2023 from,
https://sftaxcounsel.com/tax-free-mergers-and-acquisitions-under-irc-368-what-worked-and-what-
didnt/
Knight, Ray & Knight, Lee (2021, February 1). Acquiring the tax benefits of a corporation.
Journal of Accountancy. Retrieved on July 13, 2023 from,
https://www.journalofaccountancy.com/issues/2021/feb/tax-benefits-of-a-corporation.html
CCH Publications (2023). 2023 U.S. Master Tax Guide. 106th Edition. Wolters Kluwer Editorial
Staff Publication. Riverwoods, IL. P 695.
