The role of a tax lawyer in the sale of a business is often misunderstood—or simply unknown. We interviewed Michael Bloom, a tax lawyer at Venable LLP, to understand what tax lawyers actually do on deals, when they should get involved, and what he wishes business owners knew before going to market. Here are his answers.
1. What is a tax lawyer?
Tax lawyers are licensed attorneys who typically practice at larger law firms. There are far fewer tax lawyers than CPAs. Even within law firms, tax lawyers tend to be significantly outnumbered by corporate lawyers. Our job is to help clients achieve their business objectives while minimizing taxes. There may be multiple roads to the same destination, but with very different fees and tolls along the way. We prepare the TripTik. And nowhere is that more evident than when an owner sells a business.
In doing planning, we work closely with a client's CPA. The client's CPA needs to be up to speed on, and comfortable with, any planning or structuring we recommend because the CPA, as preparer, must be willing to attest to the accuracy of the return. I have seen many good planning ideas undermined because of poor communication with the CPA, who then files the client's return in a manner that is inconsistent with the desired structure. Thus, the best and smoothest outcomes are achieved when your tax lawyer and CPA work as a team long before the return is due.
2. When do tax lawyers typically get involved when a client is selling a business?
The answer might be never. Not every law firm handling M&A transactions has tax lawyers. Business law firms without tax lawyers can still take a transaction from LOI to close with their client getting paid at the end, but that doesn't mean the deal was structured efficiently. It may have been. But if tax opportunities were missed, the seller may never know.
Thus, when a client is pricing out law firms for a sell-side M&A transaction, they should look at more than just the headline price. They should understand the scope of services that firm is offering for their fee—and, if it's important to the client, whether that scope includes any business or shareholder-level tax planning. In general, larger corporate firms are more likely to have tax lawyers on their M&A team. That is usually how it works at Venable LLP. For those firms, the tax lawyer gets involved when the corporate lawyer running the deal calls them.
There are many reasons why you want an experienced corporate lawyer running your deal. One of those reasons is their ability to spot tax issues and pull in their tax colleague. The corporate lawyer might not remember how a tax problem got solved last time, but they probably remember what caused it. Tax issues might seem novel to you, but for folks who do this day in and day out, tax problems are recurring pathogens. You want a corporate lawyer with a mature immune system. That saves time, and lawyers (still generally) bill by the hour.
3. What are your thoughts on that timing?
Putting the tax lawyer behind the deal lawyer in the process has disadvantages. Some of the most valuable tax planning opportunities arise years before a transaction. When the deal lawyer serves as the gatekeeper for involving tax counsel, the timing of tax advice follows the deal process rather than the planning opportunities.
By the time a letter of intent is signed, certain strategies may no longer be available. A higher valuation may make transferring shares to non-grantor trusts prohibitively expensive. An S corporation might have benefited from restructuring years earlier to pursue qualified small business stock treatment. Or the seller may have lost the leverage to negotiate a tax gross-up without appearing to re-trade the deal. Once the LOI is signed and the corporate lawyers have prepared draft transaction documents, our role tends to shift toward risk allocation of unknown tax issues as opposed to identifying ways to create value.
Not every strategy requires years of planning. Some can be implemented shortly before signing or even afterward. The challenge is knowing which opportunities apply and when the window closes—and that's why tax lawyers always say, "call us early"—certainly before an LOI is signed. Ideally, 1-2 years before the sale event.
4. What do you wish sellers of businesses knew when going to market?
Don't assume your advisors are looking out for your personal tax situation. Many clients think that between the investment banker, wealth manager, CPA, and M&A lawyer, tax is covered. That's a reasonable assumption—after all, that's a lot of sophisticated people—but it's often wrong.
I've gotten two calls this year from prospective clients looking for ways to mitigate the tax on their sale proceeds after their deals had already closed. At that point, the horse has left the barn. In one case, there was a relatively straightforward planning opportunity that could have saved the client a couple million dollars on a $25 million payout.
The prospective client was the founder and CEO, and he had hired sophisticated advisors to handle the transaction. So how did that opportunity get missed? My suspicion is that the law firm handling the transaction represented the company, not the shareholder. In the normal course, the firm's tax lawyers would have reviewed the purchase agreement and negotiated the tax provisions. But nowhere in that scope was anyone necessarily charged with asking: How do we minimize the founder's personal tax bill on the sale?
Those are often treated as separate workstreams, but they shouldn't be. The timing and structure of the deal inform the personal tax planning, and the personal tax planning can inform how the deal should be structured.
So, before the LOI is signed, every seller should ask: Who is responsible for making sure this deal is structured so that I personally keep as much of the proceeds as possible after tax? And if you haven't met that person yet, you should probably ask why.
I also recommend having your lawyers—corporate, tax, and trusts and estates—under the same roof whenever possible. You wouldn't assemble your surgical team one doctor at a time from different hospitals and introduce them in the operating room. Yet that's essentially how many people assemble their legal teams on transactions.
5. How can I involve a tax lawyer cost-effectively?
You don't need to commit to a six-figure legal bill. For a growing company with limited cash, an initial engagement can be narrowly scoped to identifying potential opportunities and deadlines. More extensive planning or formal tax opinions can come later, if warranted. The goal is to get educated early.