Mergers & Acquisitions: Who Gets the Employee Compensation Deduction?

June 17, 2013

What is more precious than the workforce that you have trained and nurtured over the years? Quite often, human capital-related tax issues stemming from ill-advised structuring and planning strategies create employee resentment.  This resentment can jeopardize employee goodwill and loyalty, affecting the overall long-term stability of your business model. As the saying goes, “you are only as good as your people.”  When planning and negotiating a business transaction, you must carefully monitor how employee compensation taxation matters will affect the disposition of the whipsaw effect, which can adversely affect workforce synergy, impeding productivity and creativity.

There is nothing more frustrating than to negotiate a deal and find out after it’s too late that your workforce will be taxed differently or that your business is not entitled to the employee compensation deduction. For example, a common scenario often overlooked by inexperienced practitioners and planners is that the party that cuts the check is not necessarily the taxpayer that is entitled to the deduction.  Typically, it is not a straightforward determination rule and quite often it involves anomaly tax provisions like Sec.  83 and the regulations issued thereunder as to  which taxpayer (the buyer or seller) is entitled to the compensation deduction with regards to accelerated payment of unvested restricted stock, including certain stock options and other compensatory payouts items due to change of control events.  There is also a special rule called the “next-day-rule,” applicable under consolidated tax filing situations that determine which party is entitled to the deduction.

Finally, to add more complexity, in the context of a C Corporation sales transaction, you need to pay close attention that the executed stock purchase agreement (SPA) specifically addresses all of the special reporting and election requirements with regards to accelerated payments constituting parachute payments under Sec 280G (i.e., to prevent disallowance of deduction rules and excised penalty imposition provisions to the recipient employees).

Next time you are involved in the planning phase for any kind business acquisition transaction (i.e., stock, asset, merger or combination thereof) and you want to optimize and neutralize potential negative tax implications involving employee compensation matters, please contact your Aronson LLC tax advisor or Tax Director Jorge L. Rodriguez, CPA at 301.222.8220.