Pass-through entities elevate holding period concerns to a high level because they offer the option of exiting at either the asset level (sale by the entity of its assets, which may include equity interests in subsidiaries) or the equity level (sale by the owners of their shares in the S corporation or partnership interests in the partnership). 

The “golden parachute” rules of Sections 280G and 4999 come into play for certain individuals that receive compensation in connection with the transaction that equals or exceeds three times the individual’s average compensation for the portion of the past five years that they have worked for the corporation.

Generally speaking, the goal for any rollover investment should be tax-deferral.  However, there are two primary issues to consider: (1) the amount deferred, and (2) whether deferral is actually optimal.  

Your sell-side considerations will vary significantly based on the tax status of the selling company you are selling, the tax status of the buyer entity, and the amount of any rollover equity you’re taking as consideration in the transaction. The following is intended as a guideline for considerations with links provided for more information on certain issues.

If you’ve hung out in middle market M&A long enough, you’ve heard of a Section 368(a)(1)(F) reorganization transaction (the cool kids just call them F Reorgs). It’s not important that you understand the legal and tax steps involved in an F Reorg, but it is important that you understand their benefits and risks.

No one paid a lot of attention to Section 163(j) when it was passed back in 2017. The limitation it applied to interest expense deductions – 30% of a taxpayer’s EBITDA – just didn’t come into play very often. Interest rates were low and the addback of tax depreciation and amortization resulted in a threshold that only rarely impacted a taxpayer’s interest expense deduction.

Why invest through a pass-through (generally limited liability company taxable as a partnership), when the effective federal income tax rate (29.6%-37%) is higher than the effective federal income tax rate for corporations (21%)?

Frequently, companies will forego a sell-side tax diligence process, reasoning that there’s no reason to pay for diligence of their own when a buyer is just going to discover any issues during their diligence process and the seller can respond to those issues if and when they arise.

Unlike normal investments, which have a one-year period in order to be taxed at favorable long-term capital gain rates (20%, federal), if you’ve held your investment for less than three years, you get taxed at the short-term capital gain rates (37%, federal). 

There’s a lot of noise thrown around in discussing M&A structuring and the terms used – 338(h)(10), reverse triangular, double dummy, F reorganization – are all relevant and important…