So your company is being acquired in an all-cash deal, and now you’re wondering how to avoid a massive tax hit?
You’re not alone… and you’re right to be thinking ahead.
And now you’ve got to figure out how to make the most of this acquisition… and how to not totally go under from the tax implications of it.
We often focus on how to prepare for IPOs here at KB Advisors, but cash acquisitions come with a very different (and intense) set of tax consequences.
For one thing, they’re pretty much a one-time deal & it’s done.
The acquiring company buys out all of your shares in one go, and that’s that. (Versus in an IPO when you might have one big initial cash-out, but your shares keep vesting over time and you have options to buy stocks & cash out more in the future.)
In a cash acquisition, everything gets sold: your options, your RSU, and your shares. They’ll all be cashed out… and you’re pretty much getting paid a lot of money whether you like it or not. You don’t have much choice in the matter.
Your taxes will be affected, and if you haven’t gone through an IPO or an acquisition before, it could be the biggest tax bill you’ve ever seen in your life. ????
Let’s walk you through how to prepare for your cash acquisition tax implications in 3 clear steps.
One: Prepare for The Most Epic Tax Bill of Your Life – The Tax Implications of an All-Cash Acquisition
Like I said, when it comes to all-cash acquisitions, you get paid whether you like it or not… and any time you get paid, the IRS gets their share… which means there’s a lot of fun tax math ahead of you. (Or your accountant.)
Unlike IPOs, where you can plan over time, cash acquisitions offer no flexibility for timing. The entire transaction is taxed in one go.
You can, however, figure out the different types of shares you have and what percentages they’ll be taxed at.
Qualified Small Business Stock: The Lowest Tax Rate
If you have shares that you’ve held for more than five years, these may qualify for certain tax exclusions.
But you must claim these exclusions when you file… otherwise, they’ll be taxed as long-term capital gains, and you’ll miss out on the benefit.
Long Term Capital Gains: A Lower Tax Rate Than Ordinary Income
If you’ve had shares for more than one year, they qualify for the long-term capital gains tax rate, which is lower than regular income tax.
The important thing here isn’t just selling them as stocks that qualify for long-term capital gains. Know your cost basis for these stocks so you only pay what you owe, and don’t accidentally overpay on them.
Knowing your cost basis on long-term capital gains stock is particularly important if you exercised any ISO, and had to pay any Alternative Minimum Tax.
Ordinary Income + Short-Term Capital Gains: Standard Income Tax Rate
If you’ve had any shares for less than a year, these are considered short-term capital gains and are taxed at the same rate as ordinary income.
This means the tax rate is higher, but that doesn’t necessarily mean you’re doomed to paying it all in full.
For example, if you exercised ISO the same year as the acquisition, the AMT gets wiped out, and taxes are based solely on the acquisition price. (And you don’t have to pay extra because of the AMT.)
This situation is similar to selling your shares immediately after exercising during an IPO when stock prices drop… You limit exposure to AMT by keeping all activity in the same calendar year.
Unexercised Stock Options & RSU = Ordinary Income: This is Where Cash Acquisition Tax Implications Really Bite You
If you’ve got stock options available that you haven’t exercised yet, the entire sale is treated as ordinary income. This can push you into a higher tax bracket, especially when double-trigger RSUs get released at the time of acquisition.
The (kind of) good news is, any NSO (nonqualified stock options) should have some mandatory income tax withholdings done by your company… though they may not be enough to cover your bill completely. But ISO (incentive stock options) may not have any withholdings done at all.
It’s important to know how much of each stock option you’ll be selling, what the withholding rate is, and how much extra you owe for each one.
Not to mention, an acquisition is usually one of those things that will trigger the release of any double-trigger RSU shares you’ve been vesting over time, so all of those will release. And when they do, you’ll be taxed for the number of shares you sell at the acquisition price… at the ordinary income rate. Yes, it’s a lot of money. But it’s better to be aware of the amount now than to be surprised at tax time.
Tip: Read the documentation from your company carefully… it should explain how much is withheld and what’s expected from you.
Two: Figure Out Cash Acquisition Cash Flow Logistics
After you’ve figured out the math around your upcoming tax bill, it’s time to plan how the money will reach you (and when).
Ask yourself:
- How will the cash from the acquisition land in your bank account?
- When will you get paid and have access to the money?
- How does that line up with any estimated tax payments you need to make or yearly tax filings?
Every scenario is different, but this is more or less what you can expect to happen:
When the acquisition begins, your money gets placed into a holding account.
Then, once the acquisition closes, the acquiring company will open a bank account for you and place the money there. From that point on, the cash is yours.
Remember, taxes are triggered by the acquisition’s actual closing, not by how soon you decide to touch the cash. So don’t be afraid to access the money as soon as it’s available.
What if the cash is in escrow?
A lot of times, some companies delay a portion of your payment by holding it in escrow, just in case unexpected costs arise during acquisition finalisation. Meaning… not all of the money gets released at once. They do this to protect themselves in case there are any unforeseen expenses with closing the deal.
If this is the case, it’s usually not a very big deal: You should have more than enough to cover your tax bill in the initial funds transfer, even if they do hold some back.
But it’s crucial to understand how much is delayed, and when it will be released, so you can:
- Make estimated tax payments on time
- Align your financial goals with your payment schedule
All of these details should be in the communication documents you receive from the acquiring company, so make sure to read them carefully.
Three: Update Your Financial Plan
While the taxes can sting, a cash acquisition often gives you the capital to make real progress on your financial goals.
With the money left over, most people use the cash to advance their financial lives forward in significant ways.
Project Your Cash Acquisition Tax Implications
First things first, obviously, you need to plan for that tax bill and get it out of the way.
Don’t just assume that any money you get out of the acquisition automatically has the taxes taken out like your normal paychecks do. Even if your company does do some withholding, chances are it won’t be enough, and you’ll still owe extra.
Using last year’s tax return, your most recent pay stub, and the details of how much you’ll get out of the acquisition, work with a tax professional to estimate whether you need to make an advance payment to avoid penalties.
(As long as you pay 110% of last year’s federal taxes, you’ll avoid a penalty, even if it does turn out that you’ll owe more later.)
Look for Ways to Lower Your Tax Implications
Once you’ve figured out how much you’ll owe, you can still find creative ways to lower your tax bill, even if you don’t have as much flexibility as with an IPO.
You could do this by maxing out your pre-tax 401(k), by increasing charitable giving, or other ways your financial advisor can figure out for your specific situation.
Finally: Put Your Money to Work!
Now’s the fun part!
Once your taxes are handled, you can use the rest of the proceeds to fuel your goals. Many of our clients use cash from acquisitions to:
- Paying off debt
- Buying a house
- Making more investments
It’s not just about surviving the tax bill… it’s about thriving after it.
Your Cash Acquisition Tax Implication To-Dos:
So, to review:
As soon as you find out your company’s going through a cash acquisition, take these steps:
- Do the math & prepare for an epic tax bill
- Know how much money you’ll get & on what dates. Also, how you’ll be able to access that money, and plan on doing so ASAP.
- Pay your taxes & use your money to reach your next big financial goal.
It’s a lot of work, but an expert financial planner and tax preparer who understands tech employee stock compensation and cash acquisition tax implications can be a BIG help.
To book a call with me or one of my associates, click here or use the button below. We’ll talk you through everything you need to know, and help you make the most efficient, profitable plan for your unique situation.
