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Business Tax

Preparing for the Tax Implications of an IPO

Marc Mehlman  

Marc Mehlman  

You did it. You’ve built a company from the ground up that’s become so successful, it’s now time for a new chapter—an Initial Public Offering (IPO). By going public, you’ll be able to raise capital to grow and expand in ways you never dreamed possible.

Experts tell you to prepare early, making sure your company “acts public” for at least a year ahead of that first sale of stock. You’re ready to commit considerable resources to the IPO process—from building a superior management team to developing a thoughtful investor relations strategy that will entice the right investors.

While you lay the foundation for a successful transition to public status, it’s also critical to build a solid tax strategy and infrastructure that adheres to public tax and accounting requirements and minimizes your exposure. Because some private companies use income tax basis accounting as opposed to generally accepted accounting principles (GAAP), many will experience major changes when it comes to tax and accounting practices as a public company.

To minimize adverse tax consequences of going public, it’s important to build a solid IPO tax strategy 6-12 months ahead of time that will carry your company forward into the public arena. Here’s how.

Building your IPO tax strategy

  1. Develop your tax team
    As you prepare your company for an IPO, it is critical to build a knowledgeable and independent tax team that can develop an appropriate tax structure with proper tax controls, financial disclosure procedures, and an appropriate reporting environment. While many companies with limited resources benefit from outsourcing this type of work, some organizations make an early decision to invest in comprehensive tax technology to keep tax work in-house from the very start. It’s important to analyze both options to determine what works best for your company.
    Overall, the goal should be to develop a governance structure that incorporates tax strategies into business and financial decision making as a public company. All this, of course, while ensuring auditor independence as defined in the Protecting Investors through Audit Oversight (PCAOB) and Security and Exchange Commission (SEC) independence requirements.
  2. Polish your internal controls
    As most of us know, an IPO will initiate compliance with Sarbanes-Oxley (SOX) requirements. SOX requires companies to verify that their financial reports are accurate and complete, as well as that the proper controls are in place to quickly forecast gaps and root out fraud. As such, your tax team should focus on polishing internal controls to adhere with SOX more than a year before your company goes public. Critical to your compliance with SOX is how you manage your data and the controls you have in place to protect and audit that data. More on this topic in a bit.
  3. Adjust to a quarterly close
    One of the toughest adjustments for a private company going public is filing financial statements in a much shorter window of time, so practicing the quarterly close process ahead of an IPO is critical.
    Typically, your tax department will only have one to three days to complete analysis once the final quarterly financial data is received, so timing challenges spill over into the provision process as well. As such, it’s smart to front-load as much of the tax provision process as possible prior to quarter close.
  4. Enhance your provision model
    To properly reconcile financial statements with relevant tax provisions, it’s nearly compulsory to implement advanced technology solutions that automatically bring together financial data with provision. While many companies use a spreadsheet-based tax provisioning system, the benefits of a technology-based software platform include automatic uploads, more consistency and faster closes. Regardless of what type of model you choose, supporting workpapers should incorporate all elements necessary to facilitate company and auditor review. The time to invest in a technology solution is prior to creating your processes. The solution will facilitate the creation of best practices and ensure the tax team hits the ground running on day one.
  5. Advance your tax strategies
    Once your company goes public, SEC filings require effective tax rate (ETR) reconciliation disclosures, making them open to public scrutiny. As such, consider implementing ETR reduction strategies well before going public to enjoy a reduced and more stable ETR once it’s publicly disclosed.

Understanding IPO-specific tax considerations

In addition to high-level strategic tax planning, an IPO brings with it many specific tax considerations that should be brought to the forefront of discussions well ahead of going public to avoid unnecessary tax and valuation issues.

  • Uncertainty in income taxes
    In preparation for public company reporting requirements, businesses should perform a thorough review of tax positions taken on prior year’s tax returns to determine if any are uncertain and take the necessary steps to address and disclose such positions ahead of the IPO.
  • Attribute limitations (IRC 382 and 383)
    An IPO often times results in a “change of control” triggering tax attribute limitations. Make sure your tax team evaluates such a change ahead of time to fully understand and adjust for the implications.
  • Valuation allowance
    If your company anticipates using a portion of the IPO proceeds to pay off debt, your tax department should reassess your company’s tax position upon completion of the IPO.
  • Stock valuation
    409A valuation is a formal report that tells you the value of your company’s common stock. When you give stock options to your employees, you are giving them the option to buy equity in your company in the future at a price (known as the “strike price”) that is determined today. Your tax department will need to evaluate the impacts of stock compensation, the potential for disqualifying incentive stock option treatment, and other issues that may arise in relation to the 409A valuation. If your strike price was too low, it can trigger a book accounting charge and tax issues.
  • Limits on deductible executive compensation
    IRC 162(m) limits the corporate tax deduction for non-performance-based compensation for top executives of publicly held companies to no more than $1 million per executive per year.

A successful transition to public status

From building a comprehensive IPO tax strategy to understanding the specific tax implications of an IPO, private companies considering making an initial public stock offering must start acclimating their tax activities well ahead of going public.

The key to a successful transition to public status is found in proper tax planning. Pre-IPO tax strategies and proper due diligence gives your company the ability to address financial statement and disclosure issues before going public so you can present your financial position in the best light.

In the end, when it comes to the tax implications of an IPO, there is no such thing as being over-prepared.

For more information on comprehensive technology that can address all your tax compliance needs, visit our Thomson Reuters ONESOURCE page..

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