Careful attention to tax considerations during the course of acquisition transactions can help secure opportunities to protect and enhance value for private equity funds. While there are numerous tax issues to consider in any transaction, below are some key considerations.
Identifying Structuring Opportunities Through Tax Elections
338(h)(10) Elections for Qualified Targets
An election under Section 338(h)(10) of the Internal Revenue Code allows a corporate buyer to acquire stock while realizing the tax benefits of an asset purchase if the target is (i) a member of a consolidated group (or a non-consolidated selling affiliate) or (ii) an S corporation, and the private equity fund's corporate buyer acquires a minimum percentage of the target's stock by vote and value (after excluding any non-voting, non-convertible preferred stock) within a defined acquisition period. However, in certain circumstances a Section 338(h)(10) election may cause the seller to incur additional taxes due to the difference between the inside and outside bases in its shares. As a result, to secure cooperation from the seller, it is important for private equity funds and their counsel to identify such opportunities early in a transaction—often at the letter of intent phase—to secure the benefits of a 338(h)(10) election without having to agree to concessions later in the transaction.
Section 754 Elections for Tax Partnerships
A buyer of less than all of the equity in a target taxed as a partnership can realize the tax benefits of an asset purchase through a Section 754 election made by the target. A Section 754 election allows the partnership to adjust the basis of its assets to reflect the difference between the private equity fund's basis for the purchased equity and the private equity fund's proportionate share of the adjusted basis of all target partnership property. If a Section 754 election for the target partnership is not already in place, then it should be made on the federal tax return of the target partnership (i.e., Form 1065) for the tax year of the acquisition.
Structuring Rollover Equity
To ensure that management incentives are properly aligned, attention should be given to the value attributed to the management rollover amount when the target owners are to receive "rollover equity" in the post-acquisition tax...