06/30/2026
When business owners think about mergers and acquisitions, the focus is usually on valuation, growth opportunities, and getting the deal across the finish line. Buyers are often focused on strategic expansion, market share, or operational synergies, while sellers are thinking about liquidity, retirement, or the next stage of their business journey.
What frequently receives less attention at the outset, however, is taxation, despite the fact that tax consequences can dramatically alter the economics of a transaction for both sides.
One of the most important issues in any acquisition is the basic structure of the transaction itself. Buyers often prefer asset acquisitions because they generally receive a step-up in tax basis, which can create valuable future depreciation and amortization deductions. Asset deals also allow buyers to selectively assume liabilities and reduce exposure to unknown historical issues.
Sellers, however, frequently prefer equity sales. From the seller’s perspective, a stock or membership interest sale can produce more favorable capital gains treatment and provide a cleaner exit. By contrast, asset sales can create unexpected ordinary income exposure through depreciation recapture and, in the case of certain C-corporations, potentially trigger double taxation.
For these reasons, the structure of a transaction often should be one of the very first negotiations. A purchase price that appears attractive at first glance may look very different once the after-tax proceeds are calculated.
Another area where parties commonly encounter issues is purchase price allocation. In asset acquisitions, the purchase price must be allocated among the acquired assets, and that allocation directly affects the seller’s tax treatment, the buyer’s future depreciation and amortization deductions, and overall future tax exposure. Sellers generally prefer allocations to goodwill because it is generally taxed at capital gains rates. Buyers, on the other hand, may seek allocations toward assets that can be depreciated or amortized more quickly, often resulting in ordinary income treatment for the seller.
Adding another layer of complexity, there are certain elections, such as Section 338(h)(10) and Section 336(e) elections, that can allow parties to achieve deemed asset sale treatment while maintaining the legal form of a stock transaction. These structures can provide meaningful advantages, but they require careful analysis and close attention to implementation details in order to avoid unintended consequences.
Earnouts and contingent consideration also deserve careful attention. These provisions are increasingly common in transactions where buyers and sellers disagree on future performance expectations. While earnouts can help bridge valuation gaps, they introduce additional complexity regarding timing of income recognition and characterization of payments. In addition, M&A transactions often involve the retention of ownership so that the seller benefits from the future operations. This is often accomplished through equity rollovers. The continued ownership creates its own complexity where it is desired (as it is in most cases) for the retained equity to not create income tax consequences.
If not properly structured, payments intended to be purchase price consideration can sometimes be recharacterized as compensation for services. That distinction matters because compensation may be subject to payroll taxes and ordinary income treatment rather than capital gains treatment.
Even after the economics of the transaction are negotiated, tax issues continue well beyond closing. Well-drafted purchase agreements should clearly address responsibility for pre-closing taxes, tax return preparation, audit control, indemnification procedures, and escrow arrangements. Ambiguity in these provisions can lead to costly post-closing disputes that continue long after the transaction has been completed.
Ultimately, tax planning is not simply a technical exercise in an M&A transaction, but rather, it is a core component of the deal itself. Buyers and sellers who involve experienced legal, tax, and accounting advisors early in the process are typically better positioned to avoid surprises, preserve value, and execute a smoother transaction.
Whether a transaction involves a closely held family business, a growing middle-market company, or a strategic acquisition, understanding the tax pitfalls in advance can make a meaningful difference in the success of the deal.
If you are contemplating a business sale or purchase Katz Chwat, P.C. can help you navigate the complex considerations involved. Please reach out if we can be of assistance.
