Mergers and acquisitions in the health care industry present unique challenges that are not often present when undertaking similar transactions in other industries. Because of health care’s highly regulated nature, parties may falter if a health care transaction is not reviewed and negotiated carefully with respect to the distinct concerns that health care presents.
The parties to every health care M&A deal should consider and evaluate the tax ramifications of the transaction. There are typically several variables, such as the tax status of the parties and the anticipated structure of the deal, that can provide planning opportunities for both the buyer and the seller. In some situations, the parties’ interests may align on tax issues, while in other situations one party may prefer one approach over another due to tax issues, which can play an important role in negotiations for those that are mindful of the potential benefits and pitfalls. Through our collective tax experience at Hall Render, we are well versed in identifying tax issues during the M&A process and negotiating positions that will favor our clients. This article provides several examples of issues that may arise in your next transaction.
General Tax Considerations
- Deal Structure and Tax Implications. With every M&A transaction, there are likely multiple options for how to structure the deal ranging from a stock purchase, merger/reorganization or asset purchase. Every option has tax implications for the buyer and seller, as well as the future operations of the resulting business. Thus, one of the most important steps in a transaction is the selection of the deal structure. In a stock purchase, the value of a business is determined through buyers and sellers in the market who are actively trading, and each share of stock is valued accordingly. In an asset purchase, the overall sale price is allocated among the assets individually. Generally, an individual (non-corporate) seller often prefers a stock purchase for tax purposes because the seller’s gain typically will be subject to long-term capital gain tax rates, which are lower than ordinary income tax rates. Meanwhile, a for-profit purchaser may prefer an asset purchase because the purchaser will obtain a stepped-up basis in the target assets, which can then be depreciated in future years. These differences in tax treatment can have a material financial impact on a transaction, especially when one or more of the parties is a for-profit/taxable entity or individual. This can present opportunities for negotiation when the tax consequences are identified and discussed early in the process along with non-tax deal structure issues. In certain circumstances, non-tax issues may favor a particular deal structure (e.g., stock purchase) while tax issues could favor another structure (e.g., asset purchase). Fortunately, with proper planning, the Internal Revenue Code of 1986, as amended (the “Code”), can allow for a tax election(s) allowing a stock purchase to be treated as an asset purchase, solely for tax purposes. Other planning opportunities might also exist that warrant consideration, such as the purchase of goodwill from individual owners or a joint venture arrangement.
- Issues in Due Diligence. A necessary element of every transaction is the conduct of due diligence to identify potential legal, regulatory, and financial concerns. This review process should typically include tax matters, especially in a stock purchase. When a business entity is acquired in a stock purchase, the buyer assumes liability for the entity’s entire tax history. This creates a need for a higher level of scrutiny during due diligence in order to minimize risk of having to pay back taxes for the acquired entity. When performing tax due diligence, the review should include the prior year federal and state tax returns (at minimum, the last three years), any government audits, copies of correspondence with taxing authorities, tax sharing and transfer pricing agreements, net operating losses or credits that are carrying forward, and any potential settlement documents with the Internal Revenue Service or other taxing authorities. Meanwhile, the various measures to provide financial relief and economic stimulus in response to the COVID-19 pandemic add a new variable to due diligence reviews because participation in certain programs such as the Paycheck Protection Program can cause an organization to be ineligible for other programs such as the Employee Retention Credit. These eligibility issues should be identified and inventoried during due diligence to help ensure that the purchaser is not unexpectedly disqualified from a particular program as a result of a transaction, especially in a stock purchase where the attributes of the seller could be aggregated with the purchaser post‑transaction.
Nonprofit Tax Considerations
- Protecting Tax-Exempt Status in Transactions. Tax-exempt organizations considering an M&A transaction will have tax concerns that are different than for-profit organizations. A paramount consideration will be ensuring that the transaction will not jeopardize the organization’s tax‑exempt status. This typically requires an evaluation of the deal to confirm that it will not provide impermissible private benefit to a private individual or organization or constitute private inurement or an excess benefit transaction with respect to an insider, as such concepts have been defined and developed under the Code and related guidance. In order to support this analysis, it is common for the parties to obtain sufficient support and documentation that the deal constitutes fair market value, which would likely also be important for other health care regulatory concerns. Meanwhile, M&A transactions for tax‑exempt organizations often require scrutiny of the anticipated governing documents of the organization(s) post-closing to ensure that proper terms and conditions are included to help protect and maintain the organization’s tax-exempt status. Finally, unrelated business income tax consequences may need to be considered if the M&A transaction involves a new line of service or a change in activities post-closing.
- 501(r) Compliance for Hospitals. Section 501(r) of the Code imposes additional requirements on tax-exempt organizations that operate one or more hospital facilities in order to maintain tax-exempt status under Code Section 501(c)(3). Specifically, each licensed hospital facility operated by a tax-exempt organization is required to: (i) conduct a community health needs assessment and adopt a corresponding implementation strategy at least once every three years; (ii) establish written financial assistance and emergency medical care policies, and make these available to the public in plain language and certain foreign language translations; (iii) limit amounts charged for emergency or other medically necessary care provided to individuals eligible for financial assistance to not more than the amounts generally billed to individuals with insurance; and (iv) make reasonable efforts to determine whether an individual is eligible for assistance under the hospital’s financial assistance policy before engaging in extraordinary collection actions against the individual. In a transaction that includes a hospital facility subject to Code Section 501(r), consideration must be given to the seller’s pre-transaction compliance as well as plans for the purchaser’s continued compliance post-transaction.
As highlighted above, the tax consequences of an M&A transaction require a nuanced understanding of the type of transaction and the details of the parties involved. Tax issues can vary greatly depending on whether it is a stock or asset deal and whether there are for-profit or tax‑exempt entities involved. If you have any questions or would like additional information, please contact:
- Calvin Chambers at (317) 977-1459 or cchambers@wp.hallrender.com;
- Jeff Carmichael at (317) 977-1443 or jcarmichael@wp.hallrender.com;
- Jim Willey at (317) 977-1409 or jwilley@wp.hallrender.com;
- Kelci Laster at (317) 977-1401 or klaster@wp.hallrender.com; or
- Your regular Hall Render attorney.
Special thanks to Hannah Clarke, law clerk, for her assistance with preparing this article.
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Throughout 2020, Hall Render’s Mergers & Acquisitions Service Line will be publishing a series of articles identifying important, and often unique, aspects of health care transactions that should not be overlooked. Ranging from Real Estate to Reimbursement, this series is designed to highlight key issues and considerations relating to niche components of health care transactions.
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- Part 1: Real Estate Issues in Health Care M&A
- Part 2: Information Technology in Health Care M&A
- Part 3: COVID-19 in Health Care M&A
- Part 4: Post-Acute and Long Term Care Issues in Health Care M&A
- Part 5: The Organized Medical Staff in Health Care M&A
- Part 6: Graduate Medical Education in Health Care M&A
- Part 7: Antitrust in Health Care M&A
- Part 8: Litigation in Health Care M&A
- Part 9: Labor & Employment in Health Care M&A
Hall Render blog posts and articles are intended for informational purposes only. For ethical reasons, Hall Render attorneys cannot—outside of an attorney-client relationship—answer specific questions that would be legal advice.
