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Tax Purchase Price Allocation
Providing tax-based allocation of purchase price to acquired assets
Business acquisition transactions have become increasingly complex, with new considerations driven by tax and regulatory changes. Whether the acquisition structure is simple or complex, the buyer and the seller should get the tax purchase price allocation correct.
The federal income tax rules for allocating purchase price differ from the rules applicable under generally accepted accounting principles (GAAP). Failure to allocate the purchase price properly for tax can have a significant impact on the buyer’s opening balance sheet and deferred tax balances, and can even lead to a restatement.
Many transactions require purchase price allocations for federal tax purposes, including both taxable or partially taxable acquisitions of a business’s assets, and acquisitions of stock or limited liability company equity that are treated as asset acquisitions for tax purposes. However, the tax rules applicable to purchase price allocations for some of these transactions differ from the tax rules applicable to others. It is important to understand which tax rules apply to the specific transaction at hand. In situations involving acquisition of multiple entities’ assets or retained equity interests (e.g., tax deferred “rollovers”), the tax rules are further complicated.
The buyer and the seller both generally must report a tax purchase price allocation on their tax returns.
The buyer must allocate its tax basis among the various assets purchased. The seller must allocate the consideration it received among the various assets it sold to determine its gain (or loss) on the various assets. These allocations must be reported on the respective party’s tax return for the year in which the transaction took place.
Agreements between the buyer and seller regarding the tax purchase price allocation generally are binding on both parties. Entering into this type of agreement can be advantageous or disadvantageous, so caution should be exercised. The effect of any potential purchase price allocation agreement should be considered prior to the transaction.
Tax purchase price allocations can involve considerable complexity. Tax treatment of the target’s liabilities frequently differs from the GAAP treatment, with potentially significant effects on the purchase price allocation for tax.
In addition, the tax treatment of items such as earn-outs, noncompete covenants and retained equity is highly fact-sensitive. Depending upon the facts, these items could either represent additional consideration taxed at capital gain rates, or represent compensation subject to tax at ordinary rates, as well as applicable employment taxes and withholding requirements. For example, as described here, earn-outs that require continued services by the recipient may result in compensation taxed as ordinary income rather than capital gain, despite the fact that the earn-out is based upon the success of the business. A similar issue may arise with regard to noncompete covenants, as described here. Negotiating these issues upfront can be helpful, since an agreement between buyer and seller regarding tax treatment generally is binding on both.
Given the issues summarized above and the unique nature of certain applicable tax rules, tax purchase price allocations generally require analysis by tax subject matter specialists.
Issues that should be analyzed under the tax rules include:
- Determination of purchase price and total consideration transferred
- Measurement and recognition of liabilities assumed in the transaction, including contingent liabilities and pension liabilities
- Allocation to asset classes I–VII using the residual method under section 1060 of the Tax Code and Regulations under section 338
- Treatment of bargain purchases
- Treatment of escrow payments, contingent earn-out and deferred payments
- Treatment of percentage of completion contracts acquired
- Treatment of deferred revenue
- Treatment of goodwill and covenants not to compete
- Treatment of transaction expenses
- Treatment of depreciation and tax amortization benefits
Our tax team has extensive experience in determining tax purchase price allocations and advising on deal structuring. RSM understands the importance of meeting the basic requirements of tax returns or financial statements. We also understand that the importance of a tax purchase price allocation extends beyond these compliance requirements. We help clients—whether they are buyers or sellers—understand how the results of our analyses affect their business. We commit to clear and open communication from initial conversations through delivery of final work products. With our comprehensive approach, we go beyond the numbers and deliver value to you and your stakeholders.
Your RSM tax advisors have significant industry and technical experience to cut through the complexity for the tax consequences of mergers and acquisitions. Further, we can collaborate with RSM International’s tax professionals to meet your needs both domestically and abroad.
A hands-on, inclusive approach
RSM advisors have established a consistent process that results in accurate allocation of your business’s assets and liabilities for tax reporting purposes, including:
- Defining scope: Before you even engage RSM, your engagement team will gather information and clearly define the scope. This process concludes with a detailed scoping overview to map a clear engagement outline and avoid unexpected surprises.
- Detailing our methodology: Soon after engagement, your engagement team will request information necessary to perform the analysis. After completing the analysis, your engagement team will provide you with the calculation underlying its conclusions, including supporting descriptions of the transaction type, overall purchase price and allocation. We may also provide a technical memorandum analyzing the relevant issues, where appropriate.
- Analyzing and reviewing: Your engagement team is supported by a group of tax professionals focused on maintaining current best practices in tax purchase price allocations. The team keeps up to date with the latest tax technical updates and insights of other leading tax practitioners.
This framework creates an environment where the expectations are communicated and understood throughout the project. Ultimately, this allows us to deliver a final product that appropriately complies with the tax requirements.