Tax consequences of selling or buying a business
Author: Trevin Rasmussen
Date: January 2016
Key Points to ConsiderThe purchase price allocation dictates the tax consequences for both the buyer and seller. The goal is to strike a balance that has positive consequences sufficient for both parties to move forward and close the deal. Business owners should involve their accountant early on in the process to avoid unexpected tax consequences resulting from the sale of the business.
- You are only taxed if there is a gain on the sale or if income is earned
- Capital Gains tax rate is almost always lower than Ordinary Income tax rate
- Both the Seller and the Buyer are required to file form 8594 with the IRS disclosing how the assets of the business were transferred
- Buyers prefer asset sales, Sellers desire stock sales
- Buyers want to allocate as much of the purchase price to consulting agreements and highly depreciable assets such as equipment and vehicles
- Sellers want to allocate as much of the purchase price to goodwill and inventory
Most small business transactions are asset sales rather than stock sales. But on the rare occasion when stock is purchased it is treated as a capital gain for the Seller. The gain is calculated by figuring how much the original owners stock is worth (also called the basis) and subtracting that number from the price the Buyer is paying for the stock. You will need the help of your accountant to determine the basis and the gain.
This asset may or may not be included in the sale of the business. Many times it is just as easy for the seller to retain the receivables and collect the accounts after closing. Other times the buyers may want the receivables to satisfy their working capital needs. AR is sometimes transferred for a loss if the buyer negotiates a discount arguing that some of the receivables will be uncollectable.
This asset is normally sold to a buyer “at the Sellers Cost.” Therefore, no gain is realized by the seller for transferring this asset to a buyer. If the Seller decides to sell the inventory for more than they paid to acquire the inventory, then there will be a gain and the ordinary income tax rate will apply.
Furniture, Fixtures, & Equipment (FF&E)
This asset class is called personal property and includes everything tangible that is used by the business. FF&E is treated in one of three ways; (1) Ordinary Income, (2) Depreciation Recapture, or (3) Ordinary Loss. You will need the help of your accountant to calculate the Depreciation Recapture amount if applicable.
This asset class is commonly referred to as blue sky. It is the amount of money that is not necessary assignable to a tangible asset. It is treated as a capital gain for the seller. Obviously the seller wants to allocate as much as possible to goodwill for tax purposes. The buyer wants more allocated to assets that can be depreciated sooner than 15 years. Also keep in mind that it is difficult to find a bank that will lend against goodwill. This will limit the number of potential buyers that are able to purchase the business.
This asset class can be the worst-case scenario for both the buyer and the seller. The seller is taxed at the ordinary income rate and the buyer has to amortize the value of the agreement over 15 years. Not to mention that non-compete agreements have inherent flaws to their enforceability.
The purchase price allocation dictates the tax consequences for both the buyer and seller. The goal is to strike a balance that has positive consequences sufficient for both parties to move forward and close the deal. Business owners should involve their accountant early on in the process to avoid unexpected tax consequences resulting from the sale of their business.