The rules that govern whether and when (for example, beginning of day or end of day) are complex (resembling a patchwork quilt) and frequently not intuitive. Yet tax advisers to M&A participants must be well versed in these technical rules to properly advise their clients, both as it concerns the substantive consequences of the transaction (for example, will income from the date of closing be reported on the seller's consolidated return or be reported on a standalone return?) and the provisions of a purchase and sale agreement (for example, whether restrictions on post-closing buyer actions on the closing date should be built into the agreement).
I. Tax Year-Ends — Background
Accounting periods are one of the primary building blocks of the U.S. federal income tax system.1 They are almost always 12 months or fewer.2 Many annual accounting periods correspond to calendar years, but some don't (for example, many taxpayers compute their annual income based on a fiscal year, such as April 1 of year 1 until March 31 of year 2).3 Some transactions or events can lead to what is referred to as a "short" tax year,4 which is basically an accounting period that does not last for the normal duration. Thus, for example, if a corporation was formed on October 1 and elected an annual accounting period corresponding to the calendar year, the year of its formation would be a short year (because the tax year would extend only from October 1 through December 31).5 Similarly, if a corporation with a tax year corresponding to the calendar year liquidated on June 30 of year 2, it would have a short tax year running from January 1 through June 30.6
Tax periods (and, by extension, "short" tax periods) have several consequences. For example, tax return filing due dates generally turn on when the relevant accounting period ends.7 Moreover, tax return filing due dates generally dictate when tax is due.8 In the same vein, tax accounting periods dictate when a taxpayer is required to report the consequences of a transaction (for example, two calendar-year taxpayers might engage in substantively similar transactions, one on December 31 of year 1 and one on January 1 of year 2, but the results of those transactions would be reportable on tax returns for different years for the two taxpayers, despite occurring just one day apart).
Significantly, just like the formation of an entity or the termination of an entity, an M&A transaction can result in a short tax year. The existence (or lack thereof) of a short tax year for a target has many implications that are relevant to deal participants and their tax advisers. For example, as discussed further below, if a parent of a U.S. consolidated group sells a subsidiary to a buyer, the tax year of the subsidiary will end on the date of the acquisition (in particular, at the end of the day).9 This rule applies even when the closing of such an M&A transaction occurs before the end of the day, meaning that transactions that occur after closing but on the closing date may need to be reported on the consolidated return of the seller. If seller's tax counsel fails to appreciate this fact and does not negotiate appropriate restrictions on post-closing activities, seller could end up with an unpleasant surprise.
Moreover, in a deal in which there is no short tax year (such as in a transaction in which one private equity fund (classified as a partnership for tax purposes) sells a corporate portfolio company to another private equity fund (also classified as a partnership for tax purposes)), tax advisers need to recognize that the tax period in which the closing occurs will straddle the closing date (meaning a portion of the tax period will be before the closing date, and a portion of the tax period will be after the closing date) for U.S. federal tax purposes. Transactional tax lawyers generally refer to those periods (including in purchase and sale agreements) as "straddle periods." Tax advisers need to make sure their clients are satisfied with what the purchase and sale agreement provides regarding matters such as apportionment of taxes (between the pre- and post-closing portions of the straddle period) for indemnification purposes (including the treatment of transaction expenses), allocation of responsibility for preparing the straddle period return (and responsibility for payment of taxes reflected on that return) and allocation of responsibility for straddle period tax contests (for example, audits and litigation).
II. Tax Year-End Minutiae
The tax year-end implications of an M&A transaction turn on many factors, but none is more important than the U.S. federal income tax classification of the target. Thus, this report is organized into main headings by target type. Within each major heading, further nuances are presented, including discussion of how the tax classification of a buyer can affect the tax year-end consequences of the transaction and discussion of the effect of various special elections on these determinations.10
1 Section 441(a) ("Taxable income shall be computed on the basis of the taxpayer's taxable year.").
2 See section 441(b). But see section 441(f) (providing for some taxpayers to elect a tax year consisting of 52-53 weeks); see also reg. section 1.441-1(a)(2) (stating that, subject to exceptions (e.g., for 52-53week tax years), a tax year may not cover more than 12 months).
3 See generally section 441; see also section 7701(a)(23) ("The term 'taxable year' means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the taxable income is computed under subtitle A. 'Taxable year' means, in the case of a return made for a fractional part of a year under the provisions of subtitle A or under regulations prescribed by the Secretary, the period for which such return is made."); reg. section 1.441-1(b)(5) (defining "fiscal year" as a period of 12 months ending on the final day of a month other than December). But see, e.g., section 706(b)(1)(C) (imposing limitations on the tax year that a partnership can select).
4 Section 443(a).
5 Section 443(a)(2) ("A return for a period of less than 12 months . . . shall be made . . . when the taxpayer is in existence during only part of what would otherwise be his" tax year.).
7 See generally section 6072 (setting forth the rules related to return filing deadlines and tax year-ends).
8 See generally section 6151(a).
9 Reg. section 1.1502-76(b)(1)(ii)(A)(1).
10 This report focuses on the types of regarded (for U.S. federal income tax purposes) entities that are most frequently bought and sold in M&A transactions: (1) corporations, (2) S corporations, (3) qualified subchapter S subsidiaries, and (4) partnerships. Entities that are disregarded for such tax purposes are also frequently bought and sold, but a disposition of a disregarded entity is treated (for U.S. federal income tax purposes) as a disposition of assets, which results in no end of a tax year. Cf. reg. section 301.7701-2(a) (third sentence). A discussion of the tax year-end rules that apply to non-U.S. targets is outside the scope of this report, as is a discussion of the rules applicable to tax-free reorganizations. But see section 381(b)(1) (explaining that except in the case of "F" reorganizations, in a reorganization transaction the tax year of the distributor or transferor corporation ends on the date of distribution or transfer).
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