Banker fees, deal bonuses and financing write-offs are deductible, and the drafting of the tax liability decides whether the seller or the buyer keeps the saving.
Transaction tax deductions belong to whoever the purchase agreement gives them to. The seller's deal costs, deductible in the target's pre-closing tax period, first reduce the pre-closing tax liability deducted from the price, and any excess becomes a loss carryforward the buyer uses later. On an illustrative US share deal with 8,500,000 of deductions, the benefit is 2,125,000 at a 25 per cent rate: 1,250,000 reaches the seller automatically if pre-closing taxes are computed with the deductions, and the remaining 772,727 in present value only if it negotiates for the carryforward.
Worked in full in Closing the Deal by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The deductions arise because the seller pays for the sale out of the company. Banker success fees, transaction bonuses and option cash-outs paid through payroll, and the write-off of unamortised financing fees when debt is repaid at closing are all costs of the target, incurred on the closing date. The purchase agreement usually allocates them to the pre-closing period, so they shelter the target's income for the part of the year the seller owned it.
| Input | Value |
|---|---|
| Banker success fee | 6,000,000 |
| Deductible share under the safe harbour election | 70% |
| Transaction bonuses and option cash-outs | 3,500,000 |
| Unamortised financing fees written off | 800,000 |
| Combined tax rate | 25% |
| Pre-closing period taxable income, before deal costs | 5,000,000 |
| Target's annual taxable income after closing | 3,000,000 |
| Loss carryforward limit, share of taxable income | 80% |
| Discount rate for deferred benefits | 10% |
Revenue Procedure 2011-29 lets a taxpayer elect to treat 70 per cent of a success-based fee as deductible and capitalise the rest, so 4,200,000 of the 6,000,000 fee is deductible and 1,800,000 is capitalised as a facilitative cost under Treasury Regulation section 1.263(a)-5. Payments within the excess parachute rules can lose their deduction, and are assumed not to arise here.
4,200,000 + 3,500,000 + 800,000 = 8,500,000, worth 8,500,000 × 25% = 2,125,000 if fully used.
The pre-closing period has 5,000,000 of income. The deductions eliminate it: tax for the period falls from 1,250,000 to zero. Unpaid pre-closing taxes are normally a debt-like item, so if the liability is computed with the deductions, the price rises by 1,250,000 and the seller has the first part of the benefit.
The other 3,500,000 becomes a net operating loss. Losses arising now cannot be carried back and can offset only 80 per cent of taxable income in any later year. With 3,000,000 of income a year, the buyer uses 2,400,000 in year 1 and 1,100,000 in year 2, saving 600,000 and 275,000.
Present value at 10 per cent = 600,000 / 1.10 + 275,000 / 1.102 = 545,455 + 227,273 = 772,727.
Excel, with yearly tax savings in B2:B3: =NPV(10%,B2:B3)
| Drafting of the purchase agreement | To the seller | Kept by the buyer | Seller's share of 2,125,000 |
|---|---|---|---|
| Pre-closing tax accrued without the deductions | 0 | 2,022,727 | 0.0% |
| Pre-closing tax computed with the deductions | 1,250,000 | 772,727 | 58.8% |
| Plus 50% of the carryforward benefit when realised | 1,636,364 | 386,364 | 77.0% |
| Plus 100% of the carryforward benefit when realised | 2,022,727 | 0 | 95.2% |
| Plus the carryforward paid at face at closing | 2,125,000 | −102,273 | 100.0% |
The first two lines are worth fighting over first: the 1,250,000 depends only on whether the closing statement's tax liability recognises the deal costs, a drafting point often missed when the estimate is taken from management accounts that do not show them. The carryforward is the harder negotiation, because its value depends on the buyer's future income and on the Section 382 limit that applies to losses after a change of ownership, assumed here not to bind. A buyer who pays the 875,000 at face on closing pays 102,273 more than it is worth to it.
The common compromise. "When and if realised" payments, with a cap and a sunset date, put the timing risk on the seller and the computation on the buyer, which is why the seller should ask for a with-and-without calculation each year.
| Pre-closing income | Benefit through the pre-closing tax | Carryforward created | Present value of carryforward | Total present value |
|---|---|---|---|---|
| 2,000,000 | 500,000 | 6,500,000 | 1,360,631 | 1,860,631 |
| 5,000,000 | 1,250,000 | 3,500,000 | 772,727 | 2,022,727 |
| 8,500,000 | 2,125,000 | 0 | 0 | 2,125,000 |
| 10,000,000 | 2,125,000 | 0 | 0 | 2,125,000 |
An early-year closing produces little pre-closing income, so most of the benefit lands in the carryforward the buyer controls. A seller closing in February has more at stake in the carryforward clause than one closing in November. The buyer's income matters less: at 1,000,000 a year the carryforward takes five years to use and is worth 680,542; at 6,000,000 it goes in one year and is worth 795,455.
How a seller's cash at completion is built from the headline price is in how much cash a seller actually receives at completion, and the treatment of contested items in how much disputed debt-like items move the price.
Deal costs create a tax asset of roughly a quarter of their deductible amount, and the purchase agreement decides who owns it. Get the deductions into the pre-closing tax computation first, worth 1,250,000 here, then price the carryforward at its present value, 772,727, not its face. The equity bridge these items sit in, line by line from enterprise value to the price paid, is in the free workbook for this case.
Many are, in the target's pre-closing period. Transaction bonuses paid through payroll and unamortised financing fees written off at payoff are generally deductible, and under Rev. Proc. 2011-29 a taxpayer can elect to deduct 70 per cent of a success-based fee. In the illustrative case, a 6,000,000 banker fee gives 4,200,000 of deduction, part of 8,500,000 in total.
Only at a value reflecting when the buyer can use it. A 3,500,000 loss usable against 80 per cent of 3,000,000 of annual income saves 600,000 in year 1 and 275,000 in year 2: 875,000 nominal but 772,727 at a 10 per cent discount rate. Paying the face amount at closing transfers 102,273 to the seller; paying when realised shifts the timing risk back.
They reduce it, and because unpaid pre-closing taxes are usually treated as debt-like, a lower liability raises the price. In the illustrative case 5,000,000 of pre-closing income would carry 1,250,000 of tax; 8,500,000 of deal deductions eliminate it, so the seller gains 1,250,000, provided the agreement computes the liability with the deductions.
This article is one calculation from Closing the Deal. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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