What Are Your Thoughts On The Following Us Federal Income Tax Situation

WHAT ARE YOUR THOUGHTS ON THE FOLLOWING US FEDERAL INCOME TAX SITUATION

I am doing due diligence on a company that is much larger than others I have looked at so far. The company is very asset light so depreciation would be minimal and amortization has been ignored due to the long write-off period. The acquiring entity will be taxed as an S-corp and I will have 100% equity. The following thought came to mind. Imagine the following scenario:

EBITDA/cash flow: $2,500,000
Enterprise value: $10,000,000
Equity injection: $1,000,000
Bank financing: $4,000,[redacted]year term, 6% APR, $55.5k monthly payment)
Seller carry: $5,000,[redacted]year term, 6% APR, $77.3k)
Net Income (ignoring amortization - EBITDA less interest payments): $1.989mm
EBITDA after debt service: $905.9k
US federal taxes due on Net Income in the first year: $903.4k

Am I missing something here? If I do this deal I will barely be able to afford the taxes. As loan payments shift to have lower interest each month/year the situation only worsens. If I'm thinking about this correctly, how can I make this work? What creative yet legitimate ways are there to decrease my tax liability?

Thanks for any and all help.

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searcher University of Virginia-McIntire - McIntire School of Commerce - 08/10/2021

Goodwill is amortized over 15 years. Given it is asset-light as you say I wouldn't ignore as it could be $500k / annually.

Why not acquire as a C-Corp. You will be repaying debt at a much lower % as it appears you live in a state with high taxes. This way you will repay at 21% fed + state C corp tax. Once you get some breathing room you can augment salary (within IRS guidelines) to get cash out during holding period.

On exit you will avoid taxes on first $10 million assuming you

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professional Concordia College, Moorhead - 08/10/2021

Shaun, there's more to this than your calculation shows. Message me at [redacted] if you'd like to discuss further. We can discuss your personal goodwill question as well.

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searcher University of Pennsylvania - The Wharton School - 08/10/2021

seems like you have $550K of interest expense + 650K of goodwill amort
=2.5M EBITDA - 1.2M

= 1.3M taxable income
@30% = 390K taxes
= 910,000 net profit after tax

searcher New York University - Leonard N. Stern School of Business - 08/10/2021

...don't we need to include principal paydown?

So $1.3m taxable income
Less $390k taxes
Less $1.2m principal payments year 1
= FCF of $400k end of year 1

searcher Utah State University - 08/10/2021

Exactly.

Additionally, Jason has calculated the federal taxes incorrectly. The US Federal tax rate is 37% for taxable income over $622k (married filing jointly). The tax bill on $1.3mm is $418k.

professional New York University Pennsylvania State University The Dickinson School of Law State University of New York at Albany - 08/10/2021

Why are you acquiring an S Corp? Make the seller undergo an F Reorg/LLC conversion and acquire the post-reorg LLC, then you'll be able to amortize/depreciate the purchase, which will largely eliminate your tax liability.

I'm not acquiring an S-Corp. But I suppose I underestimated the value of the amortization. In your experience can goodwill be amortized over ten years or 15 years?

professional New York University Pennsylvania State University The Dickinson School of Law State University of New York at Albany - 08/11/2021

Goodwill is 15 years, but different assets have different periods. DO you have a tax advisor on this? You really could lower your tax bill via relatively basic structuring. [redacted] if you'd like to talk more

searcher IE Business School University of Southern California Washington University in St. Louis - 08/11/2021

I tried posting this earlier but my browser crashed; sorry if my post gets duplicated.

As others have mentioned, the goodwill amort is material & shouldn't be ignored, even though it gets amortized over 15 years.

However what's also causing problems for you is that your largest source of funding has the shortest term of repayment. Seller Financing (or Earn Outs, etc.) can be great, but they come with a catch because every Seller I've spoken to isn't comfortable going past ~5

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lender California State University, Sacramento - College of Business Administration - 08/11/2021

Thanks James! We also have weekly office hours where we touch on goodwill lending and larger deals. Email us directly and we can send you a link. [redacted]

intermediary The University of Chicago - Booth School of Business Illinois Institute of Technology Cleveland State University - 08/11/2021

I entered your numbers in my software. 30 seconds later the results are: Cash flow after paying federal and state taxes is 383, 411, 456, 501, & 548. Your IRR is 73.%. If you exit at the end of 5 years at same price, then $1 M equity will grow to $15.7 M. I assumed zero growth, zero assets and GW amortized over 15 years. S Corp. taxes 37% federal and 3 % state.

You will be out of bank in <5 years (banks and seller will not allow dividends).

I tested C Corp at 21%. Yo

WHAT ARE YOUR THOUGHTS ON THE FOLLOWING US FEDERAL INCOME TAX SITUATION

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