Mergers and acquisitions (M&A) continue to be a strategic solution for banks looking to enhance efficiency, adapt to industry challenges, and remain competitive in a volatile financial environment. However, the tax implications of these transactions can significantly impact their success. Understanding and proactively addressing key tax considerations is essential for both buyers and sellers.
1. The Growing Importance of M&A in Banking
Banks are increasingly turning to M&A to mitigate challenges such as unrealized losses on investment securities, reduced commercial real estate activity, and shifting depositor behavior. Credit union acquisitions of banks reached a record high in 2024, driven by a desire to consolidate resources and expand geographic footprints. However, these transactions are inherently more complex due to the involvement of multiple regulators.
2. Executive Compensation: Avoiding Tax Pitfalls
Executive compensation arrangements are a critical factor in any M&A deal. Key areas of focus include:
- Deduction Limitations (§162(m)): Publicly traded companies face restrictions on deducting compensation exceeding $1 million for certain executives. The timing of deductions for stock options and deferred compensation requires careful planning to avoid permanent tax differences.
- Golden Parachute Payments (§280G): Payments triggered by a change in control can lead to substantial excise taxes if they exceed three times the executive’s base compensation. Planning strategies include limiting payments to avoid crossing the threshold and considering non-compete agreements (should non-competes survive legal and regulatory challenges) or post-transaction employment arrangements.
- Deferred Compensation (§409A): Non-qualified deferred compensation plans must meet strict requirements to avoid immediate taxation and penalties. Proactive document reviews and compliance planning can help mitigate risks.
3. Optimizing State Tax Structures
M&A often brings exposure to new state tax jurisdictions, requiring strategic adjustments to tax structures. Key considerations include:
- Balancing capital-based/net worth taxes against income taxes.
- Consolidating or simplifying organizational structures to reduce filing obligations.
- Maximizing the use of state tax credits, incentives, and net operating loss carryforwards.
Proper evaluation and planning can lead to significant tax savings and operational efficiencies.
4. Managing Transaction Costs
Tax treatment of transaction costs plays a pivotal role in M&A planning. Costs related to facilitating a transaction, such as fairness opinions, and regulatory approvals, often need to be capitalized. Success-based investment banker fees, commonly incurred during acquisitions, may also require specific documentation to secure partial deductibility under IRS safe harbor provisions. The treatment of “milestone” payments requires special attention given withdrawal of prior IRS guidance.
5. Addressing Pension Plan Terminations
In some acquisition situations, the Acquirer may wish to terminate an Acquired Bank’s defined benefit pension plan. Surplus assets from overfunded plans may revert to the employer but are subject to non-deductible excise taxes designed to prevent excessive profits from such reversions. Effective planning is required to minimize these taxes while ensuring obligations to employees are met.
6. Timing Transactions for Tax Efficiency
The timing of an M&A transaction can significantly influence its tax outcomes. Closing too early in the tax year may result in tax net operating losses (NOLs) for the target, which can result in deferred tax assets that are disallowed for regulatory capital purposes. Additionally, planning the timing of stock option exercises, systems conversions, and other one-time costs can help optimize tax outcomes.
Looking Ahead
M&A tax planning is more than a compliance exercise; it’s a strategic process that can unlock value, reduce risks, and ensure smoother integration. Taking a proactive approach to tax planning is critical for the long-term success of any merger or acquisition in the banking sector.
If you need further guidance or have any questions on this topic, we are here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
