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You are the general counsel of a public company, and the company’s board has determined that it is in the best interests of the company’s stockholders to examine and explore all strategic alternatives to increase stockholder value, including a sale of the business. Although there are still many steps that will need to be taken and the ultimate decision may be to continue operating as an independent public company, certain impending tax law changes may influence your decision and the timing thereof.
Tax Rates are Rising!
One issue that you must always examine in exploring the potential sale of the business is the tax result stemming therefrom, which may significantly influence the timing and structure of the any potential transaction. Currently, there are several federal tax law changes due to become effective on January 1, 2013. Certain tax changes are on the horizon as a result of the sunset of the “Bush tax cuts,” while other changes are a byproduct of the health care legislation enacted in 2010. These forthcoming changes certainly are not the only factors you will need to consider in determining whether to sell the business, but the changes warrant significant consideration because of the potential impact they may have on your stockholders’ after-tax return on investment.
These tax rate changes generally should be considered whether you are looking to sell equity in the company or the assets of the company. However, where equity in the purchaser or one of its affiliates serves as the primary consideration for an acquisition (and the transaction qualifies as a tax-free reorganization or contribution), or where a large portion of the purchase price is payable with a promissory note or pursuant to an earnout that isn’t paid or satisfied until 2013 or thereafter, these tax rate changes generally will not be as important because all or a portion of the gain resulting from the transaction generally will not be recognized until after 2012 in any event.
Higher Tax Rates – On The Horizon
Capital Gains Rates
For the last several years and through the remainder of 2012, long-term capital gains have been (will be) taxed at a maximum rate of 15 percent. This 15 percent rate is set to expire at the end of 2012, with long-term capital gains generally expected to be subject to tax at a rate of at least 20 percent thereafter. Consequently, if the business is sold in 2013 instead of 2012, and the transaction results in long-term capital gain, the company’s stockholders will pay at least 33% more in tax solely as a result of the delay in selling.1
Because at any particular time certain of the company’s stockholders will not be eligible for long-term capital gain with respect to their company stock, ordinary federal income tax rates should also be considered. Ordinary income is currently taxed at a maximum rate of 35 percent. However, beginning in 2013, the maximum ordinary tax rate generally is expected to increase to at least 39.6 percent, or just over 13 percent above the current maximum ordinary tax rate.
In addition to the tax rate increases discussed above, a newly enacted Medicare tax is scheduled to become applicable in 2013. This tax law change will impose (depending on the stockholder’s tax classification/situation) an additional 3.8 percent tax on the lesser of a stockholder’s (i) net investment income or (ii) modified adjusted gross income in excess of $250,000 (for joint filers). For purposes of this rule, net investment income may include proceeds from the sale or liquidation of the company’s stock, thus potentially subjecting certain of the company’s stockholders to an additional 3.8 percent tax on the sale of the business if the transaction occurs after 2012.
The above discussion is a very brief overview of some of the upcoming tax rate and law changes that may impact your analysis of the various strategic alternatives, in particular any strategic transaction that would involve the sale of the business for tax purposes. Any analysis of strategic alternatives will involve numerous options and the consideration of many different factors. Additionally, each of your stockholders’ (the taxpayer) tax and economic situations will be different and, as a result, the decision you make with regard to selling the business will result in consequences that are unique to each stockholder. However, because of the favorable federal income tax rates currently in effect and the potential application of the new 3.8 percent Medicare tax beginning in 2013, if your board of directors has asked you to consider various strategic alternatives within the next year or so, you should not ignore the tax benefits that may be realized by company stockholders from a sale of the business in 2012.
If you have any questions, please contact one of the following attorneys:
1This assumes that the total purchase price is paid at closing and does not take into account the additional Medicare tax discussed below.