Tax Connections Newsletter – Summer 2021
Robert Swenson

Merging for Tax Dollars

The COVID-19 pandemic has had an enormous impact on the economy, but different types of businesses have been affected differently. Some businesses — such as restaurants, bars, entertainment venues, airlines and other transportation companies — have suffered significant losses as a result of lockdowns, travel restrictions and other disruptions. Others — such as health care providers, technology firms and e-commerce companies — have flourished. Still, others have seen a little or modest impact on their performance.

As the struggles continue, many corporations have found themselves with net operating losses (NOLs) and other tax benefits they will not be able to use in the foreseeable future, while others have enjoyed unusually high-profit levels. One potential strategy for these corporations is to combine through a merger or acquisition so that one corporation’s losses can be offset against the other company’s profits. If the strategy is successful, it allows one corporation to take advantage of tax benefits that might otherwise go unused, while reducing the other company’s tax liability.

If you are contemplating such a transaction, careful planning is critical. The tax code authorizes the IRS to disallow tax benefits associated with an acquisition that is motivated primarily by tax evasion or avoidance. So, to preserve these benefits, the parties must be able to demonstrate one or more legitimate business purposes for the combination.

Related Read: Do Not Overlook Tax Considerations When Selling Your Business

Beware IRC Section 269

Internal Revenue Code (IRC) Section 269, “Acquisitions made to evade or avoid income tax,” states that the U.S. Secretary of the Treasury may disallow a deduction, credit or other allowance obtained through acquisition if the principal purpose of that acquisition is to evade or avoid tax. An acquisition subject to Section 269 happens when “any person or persons acquire, directly or indirectly, control of a corporation.” It also includes certain asset transfers. “Control” is defined as ownership of stock possessing at least 50% of the total combined voting power of all classes of stock entitled to vote or at least 50% of the total value of shares of all classes of stock.

Significantly, Section 269 does not disallow all tax benefits obtained through acquisition. It applies if tax avoidance is the only principal purpose of the transaction. The term “principal purpose” is subject to interpretation, but, in general, the more “legitimate” business purposes the parties can offer for joining forces the more likely it is that NOLs or other tax benefits will be allowed.

Potential legitimate business purposes include:

  • Expanding;
  • Diversifying;
  • Increasing borrowing capacity;
  • Limiting liability or reducing risk;
  • Obtaining new distribution channels;
  • Securing control of the supply chain or otherwise gaining the benefits of vertical integration;
  • Achieving economies of scale; and
  • Reducing administrative expenses.

Keep in mind that even if you clear the hurdle imposed by Section 269, other tax code provisions may limit your ability to use tax benefits after an acquisition. For example, IRC Section 382 places limits on NOL carryforwards and certain other loss deductions following an ownership change.

Weigh your options

If your company generated NOLs in 2020, the first option to consider is carrying them back to offset gains in previous years and claiming a refund. The CARES Act allows you to carry back NOLs generated in 2018, 2019 and 2020 for up to five years. If that is not an option, being acquired by a profitable corporation might be worth considering.

Related Read: Senate Passes the Coronavirus Aid, Relief, and Economic Security (CARES) Act

Complete Your Estate Plan by Adding a Power of Attorney

As you create your estate plan, your main objectives likely revolve around your family, both current and future generations. Your goals may include reducing estate tax liability so that you can pass as much wealth as possible to your loved ones.

But it is also critical to think about yourself. What if you become incapacitated and are unable to make financial and medical decisions? Thus, a crucial component to include in your plan is a power of attorney (POA).

Related Read: An Estate Plan Benefits You and Your Family

What is a Power of Attorney (POA)?

A POA is defined as a legal document authorizing another person to act on your behalf. This person is referred to as the “attorney-in-fact” or “agent” — or sometimes by the same name as the document, “power of attorney.” 

A POA can be either specific or general. A general POA is broader in scope. For example, you might use a general POA if you frequently take extended trips out of the country and need someone to authorize business and investment transactions while you are gone.

However, a specific or general POA is no longer valid if you are incapacitated. For many people, this is when authorization is needed the most. Therefore, to thwart dire circumstances, you can adopt a “durable” POA.

A durable POA remains in effect if you become incapacitated and terminates only on your death. Thus, it is generally preferable to a regular POA. The document must include specific language required under state law to qualify as a durable POA.

Who should you name as POA?

Despite the name, your POA does not necessarily have to be an attorney, although that is an option. Typically, the designated agent is either a professional, like an attorney, CPA or financial planner, or a family member or close friend. In any event, the person should be someone you trust implicitly and who is adept at financial matters.

Regardless of whom you choose, it is important to name a successor agent in case your top choice is unable to fulfill the duties or predeceases you.

Usually, the POA will simply continue until death. You may revoke a POA — whether it is durable or not — at any time and for any reason. If you have had a change of heart, notify the agent in writing about the revocation. In addition, notify other parties who may be affected.

What about health care decisions?

A durable POA can also be used for health care decisions. For instance, you can establish the terms for determining if you are incapacitated. It is important that you discuss these matters in detail with your agent to give him or her more direction.

Do not confuse a POA with a living will. A durable POA gives another person the power to make decisions in your best interests. In contrast, a living will provides specific directions concerning terminally ill patients.

Related Read: Getting Your Affairs in Order When Terminally Ill

Final thoughts

To ensure that your health care and financial wishes are carried out, consider preparing and signing a POA as soon as possible. And, do not forget to let your family know how to gain access to the POA in case of an emergency. Health care providers and financial institutions may be reluctant to honor a POA that was executed years or decades earlier. Therefore, it is a good idea to sign a new document periodically.

For more information, contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.

Forward Thinking