M&A Deal Structure Tax Considerations

November 18 2021 | by Mindy Toole, CPA, CGMA, CDA

Private equity has made strong moves into the architecture and engineering (AE) industry. This interest, combined with the fear of a long-term capital gains rate increase, has the merger and acquisition market hotter than ever before. But before you start counting the zeros, let’s talk about what’s on the mind of every Seller, second only to the purchase price, taxes. Conducting thorough tax due diligence early in the M&A process can help drive negotiations of the structure and purchase price and identify potential deal-breakers.

How Much is This Going to Cost Me?

In general, there are two options when structuring an M&A transaction. Both types deliver their own unique tax benefits that have different appeal depending on whether you are a buyer or a seller.

Buyers typically want an asset purchase for the tax deduction of amortized goodwill. In contrast, Sellers typically desire a stock sale to preserve long-term capital gains treatment. Let me introduce you to the 338(h)(10) tax election to meet somewhere in the middle. A stock sale is treated as an asset sale solely for tax purposes through this election. However, although it’s a good start, one tax election does not magically solve all the potential tax issues that a merger or acquisition may face. An item to note, the 338(h)(10) election is only available to entities taxed as an S-Corporation.

In general, there are two main areas of tax to consider in a transaction, the Seller’s deferred tax liability related to cash basis tax reporting (a potential deal-killer), and the tax due from the actual transaction.

As a Seller, your best approach to deferred taxes is through education because there are options to consider when determining the best tax strategies for your specific situation. Tax will come due through an accounting method change, an S-election revocation, or a deemed liquidating distribution into another entity not eligible for the cash basis of reporting for tax purposes. If it sounds complex, well, that’s because it is. We strongly encourage you not to go it alone. Your CPA can help you calculate this tax well in advance of any sale effort.

Another tax consideration is that pesky Net Investment Income Tax (NIIT) of 3.8%. Is your AE firm ownership considered an investment that, once sold, will trigger the tax? Most likely not, if you receive a W-2 from the entity and materially participate and it’s your “trade or business” source of income. We’ll cover this, in addition to other tax considerations, in our upcoming webinar.

Deal Structure

Proactively structuring a transaction for tax efficiency and maximum benefit is critical. Most M&A deals have at least some seller financing, even when private equity is involved. Seller financing means a note is used as one form of payment. Some deals also have an earn-out provision or paid-out performance metric as an additional purchase price. Installment sale treatment is available for both options to prevent the Seller from paying tax before cash is received.

These are just some tax considerations that should be part of your transaction planning process. Join us for our webinar on M&A Deal Structure through a Tax Lens, where we’ll compare/contrast deal structure options as they relate to tax treatment and how to maximize tax benefits.


Mindy Toole, CPA, CGMA, CDA | Stambaugh Ness

Mindy Toole, CPA, CGMA, CDA| Director, AEC Tax Practice

As a former owner at both T. Wayne Owens & Associates, PC, and TWO CPAs & Consultants, Inc., Mindy has handled many complex projects for AE firms during her career and understands the nuances that exist in the AE world. Some of her many client success stories include the time she helped a firm save nearly $9 million through a well-executed change in accounting method from accrual to cash, handling the tax side of the sale of a large multi-state engineering firm to a publicly-traded company, and successful M&A deals

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