Discover the critical importance of confirming the S corporation status in M&A deals to avoid unexpected tax liabilities. Learn from a recent case where a two-class stock issue threatened the corporation’s qualification and how it was resolved.
M&A Tax Stories
September 2, 2020
Introduction:
When acquiring an S corporation, ensuring its status is critical to avoid unexpected tax liabilities post-closure. Failure to confirm this beforehand can lead to substantial federal and state corporate income taxes.
The Discovery:
In a recent M&A transaction, the buyer conducting due diligence uncovered a concerning matter: the corporation had two distinct classes of stock. An S corporation is only allowed to possess a single class of stock. While one class was for voting, the other was for nonvoting shares. Initially, this difference did not jeopardize the S corporation qualification.
The Complication:
The issue arose when the corporation later altered its capital structure, granting differing distribution and liquidation rights to the two stock classes. This change breached the requirement for having just one class of stock.
The Solution:
To rectify the situation, the corporation swiftly reverted to a single class of stock, ensuring identical distribution and liquidation rights for all shares. Subsequently, the corporation sought an IRS private letter ruling to waive the inadvertent breach of the one-class stock rule. The IRS granted the ruling, recognizing the unintentional creation of two classes of stock and excusing the violation.
Private Letter Ruling Reference: Private Letter Ruling 201935010, Release Date: 8/30/2019 Link: IRS Ruling Document
Considerations:
The process of obtaining a private letter ruling can significantly impact deal timelines, potentially causing delays of up to 6 months. It is advisable for the selling corporation to conduct internal due diligence before initiating the sale process. However, it’s important to note that addressing issues like these entails substantial professional fees and an IRS user fee. The current IRS user fee is approximately $30,000.
By John McCauley: I help people with M&A tax issues involving privately held companies.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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