Entity v. Assets: Non-Tax Agenda 7-1 Entity v. Assets: Non-Tax Agenda Undisclosed liability exposures Third party disruptions Third party consents Unwanted assets Sales and use taxes Insurance rating issues Closing complexities Securities law exposures Clean slate mindset Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A Circle Inc. 7-2 (a) Asset Sale-Liquidation Olson Inc. $5.32 mill taxes Assets – 21.5 mill Olson Inc. Buyer Circle Inc. Seller Cash – 20 mill Liabilities – 1.5 mill Cash - $7.34 mill Cash - $7.34 mill Net After-Tax Yield Sue - $7,272,000 Doug - $5,932,000 Doug Basis 300k Sue Basis 7 Mill $1.408 mill taxes $.068 mill taxes Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Olson’s Purchase Price Allocations 7-3 Olson’s Purchase Price Allocations 197 Anti “Soft Dollar” Rule: All intangible assets amortized over 15 years – information bases, customer lists, patient files, know-how, licenses, franchises, trade names, goodwill, going-concern value, covenants not-to- compete. 1060 Priority Asset Allocation Rules: Priority One: Cash or cash equivalents. Priority Two: Highly-liquid securities, foreign currencies and CDs. Priority Three: ARs, mortgages, credit card receivables. Priority Four: Inventory and dealer property Priority Five: Other tangible assets (equipment, real estate, etc.) Priority Six: Intangibles except goodwill and going concern value. Priority Seven: Goodwill and going concern value. Note: Parties can agree on values per agreement, but not change priorities. Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Potential Asset Sale Options 7-4 Potential Asset Sale Options Liquidate, Then Sell Assets: Corporate and shareholder tax on liquidation. Same after-tax net yield with more hassle due to double transfer of assets and liabilities. Cash Merger: Same tax consequences as sale-liquidation scenario. Automatic asset and liability transfers make transaction easier, but also transfers all rights and liabilities of a merger. Installment Sale: No deferral at corporate level, but tax deferral available to shareholders if plan of complete liquidation is adopted and assets sold and note distributed with 12 months following plan adoption. Asset Sale – Deferred Liquidation: Goal would be to defer shareholder gain until after Doug (age 81 now) dies and gets 1014 basis step- up before gain recognized. Corporation likely would be personal holding company in interim and would need to dividend income. Convert to S Status Before Sale: Conversion traps and “BIG” tax Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A Circle Inc. 7-5 (b) Stock Sale for $18 million Circle Inc. Seller Olson Inc. Buyer Net After-Tax Yield Sue - $8,600,000 Doug - $7,260,000 Cash - 9 mill Cash - 9 mill Stock Stock Doug Basis 300k Sue Basis 7 Mill $1.740 mill taxes $.4 mill taxes Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

7-6 Olson 338 Election? Concept: Buyer of 80% of more of stock of target corporation over 12 month period can elect to treat as asset purchase. Basis step-up, all new corp attributes, and corporate level tax triggered. Killer: Demise of general utility doctrine gutted any value of 338 election in most cases. Why take tax hit now to get future benefit of basis step-up? Two Survivors: 338 still works where: - Corp has big NOL can than shelter corporate level tax triggered on deemed asset sale. - Stock of sub is sold and gain on sub stock is less than gain on sub assets. Then, 338(h)(10) election, coupled with 332 and 337, may produce win-win – step-up with lower tax to parent corp. Bottom Line: Demise of General Utilities triggers double tax on nearly all asset sales and stock sales with 338 election. Hence, structure of choice often is straight stock sale with no 338 election. Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A Circle Inc. 7-7 (c) Redemption - Stock Sale Combo Cash - 2.7 mill Circle Inc. Seller Olson Inc. Buyer Net After-Tax Yield Sue - $5,840,000 - $3 mill equip Doug - $7,260,000 Cash - 6.3 mill 30% Stock Cash - 6.3 mill 70% Stock 70% Stock Doug Basis 300k 30% Stock Sue Basis 7 Mill Equipment – 3 mill $1.740 mill taxes $.46 mill taxes Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Acquisition Reorg Requirements 7-8 Acquisition Reorg Requirements Control within meaning of 368(c) – Dual 80% test. Continuity of interest – varies. Measured by nature of consideration and boot. Transfers before and after not a factor. Continuity of business enterprise. Carry-on sellers business or assets. Transfer to sub or partnership allowed Business purpose. Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Acquisition Reorg Options 7-9 Acquisition Reorg Options Statutory Merger – A Reorg - Merger under state law - 50% to 60% boot allowed Stock Swap – B Reorg - No boot allowed Assets for Stock – C Reorg - Boot allowed for liabilities assumed and other boot (at 20% max) - Substantially all assets (90% net FMV) - Buyer’s stock distributed in liquidation as part of reorg. Forward Triangular Merger - Substantially all assets – same as C - Boot of A Reorg – 50% to 60% works Reverse Triangular Merger - Same as forward but boot limited to 20% Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A Circle Inc. 7-10 (d) Forward Triangular Merger Circle Inc. Seller New Sub. S New Sub Survives Tax Impacts: No recognized gain or loss for any party Doug and Sue stock basis carryover to new stock New Sub gets assets carryover basis Taxable boot allowed up to 50% to 60% 100% Stock Token Assets Doug Basis 300k Buyer Stock Olson Inc. Buyer Sue Basis 7 Mill Buyer Stock Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A Circle Inc. 7-11 (e) Reverse Triangular Merger Circle Inc. Seller New Sub. S Seller Survives Tax Impacts: No recognized gain for any party Doug and Sue stock basis carryover to new stock New Sub gets assets carryover basis Taxable boot can’t exceed 20% 100% Stock Token Assets Doug Basis 300k Buyer Stock Olson Inc. Buyer Sue Basis 7 Mill Buyer Stock Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A Circle Inc. 7-12 (f) S Corp Asset Sale-Liquidation Zero taxes Assets – 21.5 mill Olson Inc. Buyer Circle Inc. Seller S Corp Cash – 20 mill Liabilities – 1.5 mill Cash - $10 mill Cash - $10 mill Net After-Tax Yield Sue - $9,450,000 Doug - $8,450,000 Doug Basis 3 Mill Sue Basis 8 Mill $1.55 mill taxes $.55 mill taxes Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Problem 7-A (f) – Tax Computations 7-13 Problem 7-A (f) – Tax Computations Doug Sue Corporate 1.5 mill ordinary income .75 mill .75 mill Corporate 11.8 mill capital gain 5.90 mill 5.90 mill Stock basis before gain adjustment 3.00 mill 8.00 mill Increase in basis for income from sale 6.65 mill 6.65 mill Tax Basis after income adjustment 9.65 mill 14.65 mill Liquidation Proceeds 10.00 mill 10.00 mill Capital gain (loss) on liquidation .35 mill (4.65) mill Aggregate capital gain 6.25 mill 1.25 mill Tax on capital gain @ 20% 1.25 mill .25 mill Tax on ordinary income @ 40% .30 mill .30 mill Total taxes 1.55 mill .55 mill Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com

Agreement Key Components 7-14 Agreement Key Components Representations and warranties Limitations on representations and warranties Covenants pending closing Covenants post closing Conditions Legal opinions Indemnifications Due diligence Executive protections Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com