Taxes typically are one of the largest expenses on a bank’s income statement and often represent a substantial balance sheet asset or liability. When considering a merger or acquisition of a bank or bank assets, it’s critical to review not just the target’s tax situation but the potential resulting tax situation of the acquirer. Following are five key areas to consider.
1. Can the deal be structured to achieve a better tax result?
You can buy a target’s stock or assets or, under some circumstances, buy its stock and treat the transaction as an asset purchase for tax purposes. In an asset purchase, the tax basis of the acquired assets is adjusted to the purchase price. When paying a sizeable premium, asset treatment allows a tax deduction of resulting intangibles like goodwill. In a stock transaction, the target’s tax basis in its assets carries over to the acquirer; if that basis is higher than the price to be paid, stock treatment might be better, particularly if the target has any tax loss or credit carryforwards. Carryforwards are obtained only in a stock transaction, however an acquirer’s ability to use the carryforwards (and potentially other deferred tax deductions) is limited under the “ownership change” rules of Internal Revenue Code Section 382. So carryforwards might not be as valuable as you think. (For more information on section 382 and related issues, read “Will Your Target’s Tax Attributes Survive the Acquisition?”)
2. Are you inheriting target tax liabilities?
When buying an entity’s stock you acquire its known and unknown liabilities, including its tax liabilities, even if the deal is treated as an asset purchase for tax purposes. So in a stock deal, it’s critical to confirm that the target is up to date on filing and paying all required taxes. This includes income taxes as well as backup withholding; payroll, property and use taxes; and any other taxes particular to a state or local jurisdiction. Be sure someone in your organization is investigating all these non-income taxes. Review the accuracy of all tax filings and the positions taken in returns to determine if a tax authority audit would subject you to unexpected tax, interest and penalty assessments.
3. How will the deal affect your own tax situation?
If you are issuing stock as deal consideration, you’ll want to consider whether you’ll cause yourself, not just the target, to trigger a tax ownership change. These days it’s more common for acquirers to have tax loss or credit carryforwards of their own, which make the acquirer subject to the tax ownership change rules and, potentially, their limitations. Your resulting state and local tax profile should be carefully considered, especially if the target has tax filings or business activity in states you currently do not. Will you leave acquired entities as free-standing subsidiaries or merge them into other group members? Such moves could substantially increase or decrease state and local tax expense. If you, or the target, employed any tax minimization strategies, the effect of the transaction on these strategies should be considered.
4. Will your tax administration burden increase?
Will the burden (and expense) of administering your tax-related responsibilities increase or decrease once the transaction is complete? Consider changes in the number of returns to be filed or additional data tracking and tax calculations required due to inherited or resulting tax positions. Sizeable acquisitions, in particular, can quite literally tax the capacity, skill and knowledge level of the staff currently responsible for tax matters. Factor anticipated additional costs or efficiencies into your deal analysis.
5. Have you covered all the miscellaneous bases?
Be sure the transaction agreement protects you from as many contingencies as possible. For example, if buying a single bank entity from a multibank holding company, make sure the agreement clearly states who is responsible for the target bank’s tax filings and liabilities up to and through the date of closing, particularly if pre-closing tax filings are audited and adjusted. Is it clear who is responsible for information reporting related to the acquisition year? Address responsibilities and deadlines for sharing information, wrapping up any final tax returns, and filing any deal-related tax elections or forms. If the target is an S corporation, address the unique issues that can arise. Last, consider the effect of any nondeductible transaction costs or change-in-control payments.
Taxes can be a big deal in any merger or acquisition transaction. Do your homework upfront to avoid surprises.