Contingent Consideration: The Taxation of Earnouts and Escrows
Mergers and Acquisitions: The Monthly Tax Journal, Vol. 2, No. 3, pp. 3-17, July 2001
16 Pages Posted: 28 Jan 2005
Earnouts are becoming more prevalent in both asset and stock transactions. Under an earnout arrangement, all or part of the purchase price is contingent on the future financial performance of the target company or business. James C. Koenig and Craig M. Boise examine earnout techniques in their article, 'Contingent Consideration: The Taxation of Earnouts and Escrows'.
An earnout arrangement often lends itself to installment sales treatment. Mr. Koenig and Mr. Boise, therefore, examine installment sales and the installment method in the business acquisition context, including the interest charge and pledging rules and the application of the gross profit ratio to determine the extent of the tax deferral. The authors then examine installment sales in which the selling price cannot be determined, installment sales in which the sales have neither a stated maximum price not a fixed period, and distortions under the installment method.
Next, Mr. Koenig and Mr. Boise examine electing out of installment reporting, including valuation options. They then turn their attention to escrow arrangements and to taxpayers on the cash method, specifically addressing the economic benefits doctrine and escrow accounts. Finally, the authors address accrual-basis sellers, focusing on case law precedents and on income earned by escrow property.
Keywords: Taxation, earnouts, escrows, stock transactions, tax deferral, installment reporting, installment sale, contingent payments
JEL Classification: K34
Suggested Citation: Suggested Citation