Tax Planning

What are the Advantages and Disadvantages of Claiming Big First-Year Real Estate Depreciation Deductions?
What are the Advantages and Disadvantages of Claiming Big First-Year Real Estate Depreciation Deductions? 850 500 smolinlupinco

Certain businesses may be allowed to claim large first-year depreciation tax deductions for eligible real estate costs instead of depreciating them over several years. Is this the right choice for your business? You may assume so, but the answer is not as simple as it seems.

Qualified improvement property

For eligible assets placed into service during tax years beginning in 2023, the maximum allowable first-year Section 179 depreciation deduction is $1.16 million. 

It’s important to note that the Sec. 179 deduction can be claimed for real estate qualified improvement property (QIP) up to the maximum yearly allowance.

QIP includes any improvement to an interior area of a nonresidential building that you placed in service after the building was first placed in service. 

For Sec. 179 deduction purposes, QIP also includes:

  • HVAC systems
  • Nonresidential building roofs
  • Fire protection and alarm systems
  • Security systems placed in service after the building was first placed in service

With that said, expenditures that are attributable to the enlargement of the building, such as elevators or escalators or the building’s internal structural frame do not count as QIP, and you must depreciate them over multiple years.

Mind the limitations

A taxpayer’s Sec. 179 deduction isn’t able to cause an overall business tax loss, and the maximum deduction is phased out if too much qualifying property goes into service within the tax year. 

The Sec. 179 deduction limitation rules can be complicated if you own a stake in a pass-through business entity (a partnership, an LLC treated as a partnership for tax purposes, or an S-corp). 

Last but not least, trusts and estates can’t claim Sec. 179 deductions, and noncorporate lessors face added restrictions.

First-year bonus depreciation for QIP

Aside from the Sec. 179 deduction, an 80% first-year bonus depreciation is also available for QIP that’s put into service in the calendar year 2023. If your aim is to maximize first-year write-offs, you’d want to claim the Sec. 179 deduction first. If you max out with 179, then you’d claim your 80% first-year bonus depreciation.

It’s essential to note that for first-year bonus depreciation purposes, QIP doesn’t include:

  • Nonresidential building roofs
  • HVAC systems
  • Fire protection and alarm systems
  • Security systems.

Consider depreciating QIP over time

There are two reasons why you should think carefully about claiming big first-year depreciation deductions for QIP.

1. Lower-taxed gain when the property is sold

First-year Sec. 179 deductions and bonus depreciation claimed for QIP can create what’s called depreciation recapture, which means your assets will be taxed at higher ordinary income rates when the QIP is sold. 

Under the current regulations, the maximum individual rate on ordinary income is 37%, but you may also end up owing the 3.8% net investment income tax (NIIT).

Conversely, for any QIP that’s held for more than one year, gain attributable to straight-line depreciation is taxed at an individual federal rate of only 25%, plus the 3.8% NIIT if eligible.

2. Write-offs may be worth more in the future

If you claim large first-year depreciation deductions for QIP, your depreciation deductions for future years will be reduced accordingly. If federal income tax rates go up in the future, you’ll have essentially traded potentially more valuable future-year depreciation write-offs for less-valuable first-year write-offs.

Have questions? Smolin can help

The decision to claim first-year depreciation deductions for QIP or not claim them can be complicated. If you have questions about this process or need help navigating and other tax issues, contact the team at Smolin, and we’ll make sure you have the answers you need to make the best choice for your business.

Handle with Care: Including a Family Vacation Home in your Estate Plan
Handle with Care: Including a Family Vacation Home in your Estate Plan 1275 750 smolinlupinco

The fate of a family home can be an emotionally charged estate planning issue for many people, and emotions often run high when dealing with assets like vacation homes that can have a special place in one’s heart.

With that in mind, it’s essential to address your estate planning carefully when deciding what to do with your vacation home.

Keeping the peace

Before determining how to treat your vacation home in your estate plan, discuss it with your loved ones. If you simply divide ownership of the house equally among your relatives, it may cause unnecessary conflict and hurt feelings. 

Some family members may have a greater interest in keeping the family home than in any financial gain it might provide, and others may prefer to sell the property and use the proceeds for other things.

One viable solution is to leave the property to loved ones who wish to keep it and leave other assets to those who don’t. 

Alternatively, you can create a buyout plan that establishes the conditions under which family members who want to keep the property can purchase the interests of those who wish to sell.

Your plan should establish a reasonable price and payment terms, which can include payments in installments over several years.

Consider creating a usage schedule for nonowners who want to be allowed to continue using the vacation home. To help ease the costs of keeping the property in the family, consider setting aside some assets that will generate income to cover the costs of maintenance, property taxes, repairs, and other expenses that might arise.

Transferring your home

Once you’ve decided who will receive your vacation home, there are a variety of traditional estate planning tools you can use to transfer it tax-efficiently. It might make sense to transfer the interests in the property to your beneficiaries now, using tax-free gifts.

However, if you’re not ready to relinquish ownership just yet, consider using a qualified personal residence trust (QPRT). With a QPRT, you can transfer a qualifying vacation home to an irrevocable trust, which allows you to retain the right to occupy the property during the trust term.

When the term of the QPRT ends, the property will be transferred to your family, though it’s possible to continue occupying the home while paying them fair market rent. The transfer of the home is a taxable gift of your beneficiaries’ remainder interest, which is only one small part of the home’s current fair market value.

You’re required to survive the trust term, and the property must qualify as a “personal residence,” which means that, among other things, you must use it for the greater of 14 days per year or more than 10% of the total number of days you rent it out.

Discussing your intentions

These are just a few issues that can come with passing a vacation home down to your loved ones. Estate planning for this process may be complicated, but it doesn’t have to be. The key is to discuss all the options with your family so that you can create a plan that meets everyone’s needs.

Have questions? Smolin can help

Are you unsure of the best way to pass down your vacation home to your children or other relatives? Consult with the knowledgeable professionals at Smolin, and we’ll help you find the solution that meets your needs.

The IRS has Just Announced 2024 Amounts for Health Savings Accounts
The IRS has Just Announced 2024 Amounts for Health Savings Accounts 850 500 smolinlupinco

Recently. the IRS released updated guidance providing the 2024 inflation-adjusted amounts for Health Savings Accounts (HSAs).

HSA basics

An HSA is a trust established or organized exclusively for the purpose of covering the “qualified medical expenses” of an “account beneficiary.” 

An HSA can only be established for the advantage of an “eligible individual” who is covered under a “high-deductible health plan.” Additionally, the participant is not allowed to be enrolled in Medicare or have other health coverage. Exceptions include:

  • Vision
  • Dental
  • Long-term care
  • Accident
  • Specific disease

Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contributions to an HSA. This annual contribution limit, along with the yearly deductible and out-of-pocket expenses under the tax code, is adjusted each year for inflation.

Inflation adjustments for the upcoming year

In Revenue Procedure 2023-23, the IRS released the 2024 inflation-adjusted figures for HSA contributions, which are as follows:

Annual contribution limit

For the 2024 calendar year, the annual contribution limit for an individual with self-only coverage under a high-deductible health plan (HDHP) will be $4,150. For an individual with family coverage, the amount will be $8,300. This is up from $3,850 and $7,750, respectively, in 2023.

There is an additional $1,000 “catch-up” contribution amount for those aged 55 and older in 2024 (and 2023).

High-deductible health plan defined 

For the calendar year 2024, an HDHP will be defined as a health plan with an annual deductible that isn’t less than $1,600 for self-only coverage or $3,200 for family coverage (up from $1,500 and $3,000, respectively, in 2023). 

Additionally, yearly out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to go above $8,050 for self-only coverage or $16,100 for family coverage (up from $7,500 and $15,000, respectively, in 2023).

Advantages of HSAs

HSAs offer numerous benefits. Contributions to these accounts are made on a pre-tax basis. Funds can accumulate tax-free year after year and can be withdrawn without tax implications to pay for a variety of medical expenses such as:

  • Doctor visits
  • Chiropractic care
  • Premiums for long-term care insurance

Additionally, an HSA is “portable.” It stays with an account holder if they switch employers or leave the workforce. 

Have questions? Smolin can help

If you’re unsure of how these new adjustments could impact your business or you have more questions about HSAs, contact the professional team at Smolin and they’ll walk you through the implications of these changes.

Traveling for business this summer? Here’s what you can deduct
Traveling for business this summer? Here’s what you can deduct 1275 750 smolinlupinco

If you and your employees are hitting the road for work-related travel this summer, there are several considerations to keep in mind. To claim deductions under tax law, you must meet specific requirements for out-of-town business travel within the United States. These rules apply if the business you’re conducting reasonably requires an overnight stay.

Note that, due to the Tax Cuts and Jobs Act, employees are unable to deduct their unreimbursed travel expenses on their own tax returns until 2025. This is because unreimbursed employee business expenses fall under the category of “miscellaneous itemized deductions,” which aren’t deductible until 2025.

With that said it’s also important to note that self-employed individuals can continue to deduct business expenses, including away-from-home travel expenses.

Rules that come into play

The actual cost of travel—things like plane fare and rides to the airport—are deductible for out-of-town business trips. You can also deduct the cost of lodging and meals. Your meals are deductible while you’re on the road, even if they’re not connected to a business conversation or related function.

There was a temporary 100% deduction for business food and beverages provided by a restaurant in 2021 and 2022, however, it was not extended to 2023. This means that there’s once again a 50% limit on deducting your eligible business meals this year. 

Please be aware that no deduction is allowed for meal or lodging expenses that are categorized as “lavish or extravagant,” a term that’s generally interpreted to mean “unreasonable.”

Any personal entertainment costs on your trip aren’t deductible, but business-related costs like dry cleaning, computer rentals, and phone calls can be written off.

Mixing business with pleasure

If your trip includes a mix of business and pleasure, you may need to make allocations. For instance, if you fly to a destination for four days of business meetings and stay an additional three days for vacation, only the expenses for meals, lodging, and other related costs incurred during your business days are deductible.

Note that if your business activities spanned over a weekend (say you had meetings Wednesday through Friday and again on Monday), the costs incurred during the weekend portion of your trip can still be deducted.

On the other hand, if the trip is primarily for business purposes, the entire cost of the travel, including plane fare and other expenditures, may be deducted without any allocations required. 

Remember that if the trip is largely personal, none of the travel costs are deductible. The amount of time spent on each aspect of the trip is a significant factor in determining whether it is primarily a business or personal trip, though this is not the sole factor.

If the trip does not involve actual business activities but is intended for attending a convention, seminar, or similar events, the IRS may closely scrutinize the nature of the meeting to ensure it is not just a disguised vacation. Keep any documentation that will aid in establishing the business or professional nature of your travel.

Other expenses

The rules for deducting the costs of a spouse accompanying you on a business trip are quite restrictive. No deduction is allowed unless the spouse is your employee or an employee of your company, and their travel is also for business reasons.

Finally, please be aware that personal expenses incurred at home as a result of the trip are not deductible. For example, if you need to board a pet or pay for babysitting while you’re on the road, this cost cannot be claimed as a deduction. 

Have questions? Smolin can help.

If you’re looking for ways to get the most benefit from your travel deductions this summer, contact the knowledgeable professionals at Smolin, and we’ll help you navigate all of the ins and outs of deducting travel expenses for your business.

New and Improved Accounting Rules for Common Control Leases
New and Improved Accounting Rules for Common Control Leases 1275 750 smolinlupinco

On March 27, 2023, the Financial Accounting Standards Board (FASB) published narrowly drawn amendments to the lease accounting rules. This updated guidance clarifies issues pertaining to rental agreements between businesses with the same owner.

Written vs. verbal leases

Accounting Standards Update (ASU) No. 2023-01, Leases (Topic 842) Common Control Arrangements, explains how related business entities controlled by the same owner determine whether a lease exists. 

This guidance settles questions about how to approach verbal common control leases and whether legal counsel is required to determine the terms and conditions of a lease. Specifically, it gives an optional practical expedient to private businesses and not-for-profit organizations that aren’t conduit bond obligors. (A practical expedient is an accounting workaround that enables a business to use a more straightforward route to end up with the same outcome.)

The practical expedient is only applicable for written leases. Under the updated guidance, a business electing to use the practical expedient must follow the written terms and conditions of a common control arrangement to determine whether a lease exists and how to account for it. 

With a verbal lease agreement, as is typically the case between private entities under common control, the company must document the existing unwritten terms of the agreement before applying these lease accounting rules.

The lessee isn’t required to determine whether written terms and conditions are enforceable when applying the practical expedient. Additionally, businesses can use the practical expedient on an arrangement-by-arrangement basis.

Leasehold improvements

The accounting rules for certain leasehold improvements have also changed for public and private organizations under ASU 2023-01. Examples of leasehold improvements include:

  • Installing carpet 
  • Painting
  • Building out the space for the lessee’s needs

For example, a salon might install new plumbing fixtures and sinks, a chemical manufacturer could require ventilation for its production process, and a neighborhood restaurant may create a rooftop garden to attract new customers.

Under these amendments, lessees must amortize leasehold improvements over the improvements’ useful lives to the common control group, regardless of lease terms.

When the lessee no longer controls the underlying asset, the transfer of those improvements must be accounted for with either net asset or equity. The improvements will remain subject to the impairment requirements of Accounting Standards Codification (ASC) Topic 360, Property, Plant and Equipment.

Guidance for implementation

ASU No. 2023-01 is an amendment to ASC Topic 842, Leases, which was issued in 2016. It went into effect for public entities in 2019 and for private entities in 2022. This standard requires the full effect of entities’ long-term lease obligations to be reported on the balance sheet.

Starting on December 15, 2023, the updated regulations will be implemented for this and subsequent fiscal years. If a company decides to adopt these modifications during an interim period, it must be done at the beginning of the fiscal year that includes that interim period. However, early adoption is allowed for both interim and financial statements that have yet to be issued. 

If your business opts to adopt ASU 2023-01 concurrently with the adoption of Topic 842, you should use the same transition approach as this standard. If your company chooses to adopt these rules in a subsequent period, it must do this prospectively or retrospectively.

Need help understanding these rules? Get in touch. 

If your company rents from a related party, we can help you report these arrangements in alignment with this updated guidance. The accounting professionals at Smolin Lupin know how to determine whether a common control lease exists and how to report improvements and other fixes made to rented property.

Give Your Trusts New Life by Decanting Them
Give Your Trusts New Life by Decanting Them 1275 750 smolinlupinco

Creating flexibility within your estate plan using different strategies is worth considering when planning for the future. Because life circumstances can change over time (especially those involving tax laws and family situations), it’s important to use techniques to provide greater flexibility for your trustees. One such method is decanting a trust.

What is decanting?

Decanting usually refers to pouring wine or another liquid from one container into another. In estate planning terms, it means “pouring” assets from one trust into another with modified terms. 

The idea behind decanting is that if a trustee has discretionary power to distribute trust assets among that trust’s beneficiaries, they also have the ability to distribute those assets into another trust.

Depending on the language of the trust and the provisions of applicable state law, decanting may enable the trustee to:

  • Change the number of trustees or alter their powers
  • Add or enhance spendthrift language to protect the trust assets from creditors’ claims
  • Move funds to a special needs trust for a disabled beneficiary
  • Correct errors or clarify trust language
  • Move the trust to a state with more favorable tax or asset protection laws
  • Take advantage of new tax laws
  • Remove beneficiaries

In contrast to assets transferred at death, assets transferred to a trust to receive a stepped-up basis, so they can subject beneficiaries to capital gains tax on any appreciation in value. A potential solution to this problem is decanting.

Decanting can authorize a trustee to confer a general power of appointment over the assets to the trust’s grantor, causing the assets to be included in the grantor’s estate, and therefore, eligible for a stepped-up basis.

Stay compliant with your state’s laws

Many states have decanting statutes, and in some states, decanting is authorized by common law. No matter the situation, it’s essential to understand your state’s requirements. For example, in certain states, the trustee is required to notify the beneficiaries or even obtain their consent to decant a trust. Even if decanting is permitted, there may be limitations on its uses. 

Some states, for example, bar the use of decanting to remove beneficiaries or add a power of appointment, and most states won’t allow the addition of a new beneficiary. If your state doesn’t allow decanting, or if its decanting laws don’t allow you to achieve your goals, it may be possible to move the trust to a state whose laws are more aligned with your needs.

Be aware of tax implications

One of the risks associated with decanting is uncertainty over its tax implications. 

For example, a beneficiary’s interest is reduced. Have they made a taxable gift? Does it depend on whether the beneficiary has consented to decanting? If the trust language allows decanting, is the trust required to be treated as a grantor trust? Does such language jeopardize the trust’s eligibility for marital deduction? Does the distribution of assets from one trust to another trigger capital gains or other income tax consequences to the trust or its beneficiaries?

Create more flexibility in your trust with Smolin

If you want to create more flexibility with an irrevocable trust or have any questions about the tax implications of your situation, contact us for more information. 

state income tax nexus

State Income Tax Nexus: What You Need to Know
State Income Tax Nexus: What You Need to Know 956 562 smolinlupinco

Supreme Court precedent once prohibited states from collecting sales tax from out-of-state businesses lacking an in-state physical presence, no matter how much the company made in sales—but this has recently changed. 

With the United States Supreme Court decision in South Dakota v. Wayfair, Inc., individuals and businesses that sell products out of state are liable to pay the states where they sell their products taxes if they reach a certain income threshold for their sales.

If you are selling products out of state, you may be liable to pay taxes on those sales even if the amount of money you received for them is relatively small. 

Which activities of an out-of-state seller constitute Income Tax Nexus? 

There is some amount of protection for those who sell products out of state, as federal law protects those who sell physical items out of state from taxation if they meet the following criteria: 

  1. The only activity within the state is soliciting sales of tangible personal property 
  2. Sales are approved by the home office outside of the customer’s state
  3. The tangible personal property is shipped to the customer from outside of the state

Need assistance? Contact us. 

If you’re unsure whether or not you need to pay taxes on your out-of-state sales, Smolin can help. Let us walk you through the process so you don’t have to second guess anything this tax season.

What You Need to Know About Claiming Losses on Depreciated Stock
What You Need to Know About Claiming Losses on Depreciated Stock 1275 750 smolinlupinco

Do you own stock in a company whose shares dropped sharply in value or even became worthless after you purchased them? You may be tempted to simply put it behind you, but it’s important to remember that you can claim a capital loss deduction on your next tax return.

Here’s what you need to know about the rules that come into play when a stock you own is sold at a loss or loses all of its value.

Capital losses produced by stock sales

Whenever you sell stocks, they become either capital gains or capital losses. When filing your taxes, any capital gains and losses must be netted against each other based on whether they’re short-term (owned for one year or less) or long-term (owned for one year or more).

If you have short-term or long-term losses (or both) after netting, you can use these losses to offset a maximum of $3,000 of income or $1,500 for married taxpayers who choose to file separately. Any loss you incur over this limit carries over to later years until the entire amount is offset against capital gains or deducted against ordinary income. If both partners have net short-term and net long-term losses, the short-term losses will offset income before the long-term losses are utilized.

If you’ve earned capital gains during the year from selling stock or other assets, it may be wise to consider selling a portion of your losing assets to offset the cost of these gains. Selling enough of your losing assets to cover earlier gains and create a $3,000 loss is an excellent strategy for saving money when you file taxes.

Understanding the wash sale rule 

You may want to sell a stock now to lock in a tax loss even if you believe the stock will recover in the future. According to the wash sale rule, if you sell a stock at a loss and repurchase identical stock within 30 days of your sale date, you cannot claim your loss when you file your taxes.

What to do with worthless stock

If you own a stock that has become completely worthless, you can claim a loss equal to your basis in the stock. This amount is typically what was initially paid for the stock and is treated as though you’ve sold on the last day of the tax year, which is essential to note as this date decides if your loss is categorized as short-term or long-term.

When stocks have no liquidation value, they become worthless—this is due to the corporation that issued the stock having liabilities that outweigh its assets and no reasonable chance of becoming profitable in the future. A stock can still be worthless even if a corporation hasn’t declared bankruptcy. On the other hand, some stocks may still have value after a corporation has filed for bankruptcy, provided that the company is still operating.

If you discover that a stock you owned has become worthless only after you’ve filed your tax return for the year, you can amend your return to claim a credit or refund because of the loss. You can make this claim within seven years of your original return being due or two years from the date you paid.

Dealing with special circumstances when claiming losses

If you’ve been the victim of an investing scam like a Ponzi scheme, you may be able to reduce your losses by availing yourself of special tax relief provided for situations like these.

Trust your tax questions to Smolin

If you’re unsure how to claim your losses this tax season or need assistance with filing, the CPAs at Smolin can help. Contact us for more information about claiming losses on depreciated or worthless stocks.

understanding-after-tax-contributions-roth-401k-and-roth-ira

Understanding After-Tax Contributions: ROTH 401(k) and ROTH IRA
Understanding After-Tax Contributions: ROTH 401(k) and ROTH IRA 1600 941 smolinlupinco

Did you know that when it comes to your retirement account, not all contributions are created equal? Tax implications can have a significant impact on your savings. 

In fact, after-tax contributions to a ROTH 401(k) or ROTH IRA can offer significant tax benefits while traditional 401(k)s and IRAs don’t—just one of many reasons you might choose to include them in your overall plan for saving for retirement.

A bite-sized intro to ROTH 401(k) & ROTH IRA contributions

The phrase “after-tax contribution” means that the money you deposit into a ROTH 401(k) or  ROTH IRA account has already been taxed.

Paying taxes on the funds upfront can be convenient, but you’ll also enjoy several other key benefits: 

  • The opportunity to grow an asset on an after-tax basis and lock in a lower tax rate
  • Tax-free contributions and earnings
  • No income tax on funds withdrawn after you turn 59½ 

While contributions to a ROTH 401(k)/IRA don’t provide any current-year tax benefits, there are other long-term benefits to consider:

  • There are no required minimum distributions (RMDs) from a ROTH IRA
  • If a ROTH IRA is inherited, the new owner(s) are not required to withdraw all funds from the plan within ten years (as they would with a traditional IRA) 

Is a ROTH 401(k) or ROTH IRA right for you?

If you’re not in a high federal income tax bracket and don’t live in a high-tax state, making after-tax contributions to a ROTH 401(k) or IRA could be a good choice for you. You may also find these retirement savings options appealing if you don’t want to worry about income tax bills in retirement.  

If you’re looking for immediate tax benefits, it’s important to note that there are no current-year tax benefits to contributing to a ROTH 401(k) or IRA. Still, the long-term benefits outlined in the previous section can be substantial and are worth considering as part of your overall retirement savings strategy.

Maximum contributions for 2023

If you want to maximize your retirement accounts this year, you might be planning to save as much as possible by contributing large amounts to your ROTH 401(k) and ROTH IRA accounts. However, ROTH 401(k) and IRA contributions are capped by the IRS to prevent employees with higher pay rates from enjoying disproportionate tax savings.

Even if you’re only planning to make modest after-tax contributions to a ROTH 401(k) or IRA, you need to understand the contribution limits for 2023. Contribution limits for ROTH 401(k)s aren’t determined based on your total income, but contributions to ROTH IRAs may be. 

Maximum contribution for a ROTH 401(k) in 2023

For ROTH 401(k)s, the 2023 maximum contribution is $22,500. If you’re over the age of 50, you may also contribute an additional $7,500 catch-up contribution in an effort to reach your retirement savings goals more quickly. 

Maximum contribution for a ROTH IRA in 2023

For ROTH IRAs, the 2023 maximum contribution is $6,500 with a $1,000 catch-up contribution available if you’re over age 50. 

Withdrawing funds from a ROTH 401(k) or IRA

Whether you’re ready for retirement or you want to put your money toward a particularly large expense, you’ll eventually need to withdraw the funds in your ROTH 401(k) or IRA. To maximize your money, timing is everything—as is understanding the individual rules for each type of account.

Withdrawals from a ROTH IRA are penalty-free (and tax-free) after a five-year holding period and after you reach age 59½. If you withdraw before that age, there are no penalties on withdrawals of contributions. However, your earnings from the withdrawal will be subject to federal income tax and a 10% penalty.

Similarly, if you take a hardship distribution from your ROTH 401(k), income tax and a 10% penalty will be applied. However, you may be able to avoid the 10% penalty if the hardship distribution meets one of the exemptions, so be sure to check with your accountant before moving any money. 

Questions? We’re here to help. 

After-tax contributions to a ROTH 401(k) or IRA offer several important benefits to support the growth of your retirement savings, but you might find that navigating the contribution limits, tax implications, and other factors is easier with advice from a professional.

We can evaluate the possible effects any financial decisions may have on your retirement savings, and assist in ensuring that you’re following the guidelines associated with your retirement savings account. Contact us today. 

Understanding the Tax Implications of Merger and Acquisition Transactions

Understanding the Tax Implications of Merger and Acquisition Transactions
Understanding the Tax Implications of Merger and Acquisition Transactions 1600 941 smolinlupinco

As a result of rising interest rates and a slowing economy, last year’s merger and acquisition (M&A) activity decreased significantly. According to S&P Global Market Intelligence, the total value of M&A transactions in North America was down 41.4% in 2022 (compared to 2021). 

But in 2023, some analysts anticipate increased M&A activity in some industries. If you’re thinking about selling or buying a business, it’s important that you understand the tax implications. 

Two approaches to M&A transactions

According to current tax law, M&A transactions can be structured in one of two ways: 

1. Stock/ownership interest

If the target business operates as a C- or S-corporation, a partnership, or an LLC that’s treated as a partnership for tax purposes, a buyer can directly purchase the seller’s ownership interest. 

The option to buy a stock of a C-corporation may become more appealing with the current 21% corporate federal income tax rate, as the corporation will pay less tax while generating more post-tax income. Additionally, any built-in gains from appreciated corporate assets will be taxed at lower rates when sold. 

Ownership interests in S-corporations, partnerships, and LLCs have also become more appealing due to the current individual federal tax rates; the passed-through income from these entities is also taxed at a lower rate on a buyer’s personal tax return. However, it’s important to note that these individual rate cuts will expire at the end of 2025. 

2. Assets

Another option is to purchase the business assets, which may be ideal when a buyer only wants specific assets or product lines. If the target business is a sole proprietorship (or single-member LLC treated as a sole proprietorship for tax purposes), purchasing business assets is the only option. 

Choosing the right option

The right approach to M&A transactions depends largely on the goals of those involved. 

What buyers want

Buyers often prefer to purchase assets rather than ownership interests. This is because, generally, a buyer’s primary goal is to generate enough cash flow from an acquired business to be able to pay any acquisition debt while also providing an acceptable ROI. As a result, buyers tend to be concerned about limiting exposure to unknown liabilities and minimizing post-transaction taxes. 

A buyer can step up—or increase—the tax basis of purchased assets to reflect the purchase cost. When certain assets (such as receivables and inventory) are sold or converted into cash, a stepped-up basis lowers taxable gains. It can also increase depreciation and amortization deductions for qualified assets. 

What sellers want

Sellers generally prefer stock sales for both tax and non-tax reasons. One objective is to minimize a sale’s tax bill, often achieved by selling business ownership interests (corporate stock or partnership or LLC interests) instead of business assets. 

When a stock or other ownership interest is sold, liabilities typically transfer to the buyer. Additionally, any gain on sale is often treated as lower-taxed long-term capital gain—assuming ownership interest has been held longer than one year. 

Buying or selling a business? Contact a financial professional.

Buying or selling a business is a significant transaction with far-reaching impacts. If you’re considering an M&A transaction, it’s important to seek assistance from a professional before finalizing a deal—because after the transaction is complete, it may be too late to get the best tax results. 
That’s where Smolin comes in. Contact us to speak to a knowledgeable tax advisor.

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