The following information is provided as a guide to present thinking points for the seller of a business to consider in order to encourage you to utilize the services of an experienced M&A accountant. This information should not be construed as accounting or legal advice.
The way the purchase price is allocated dictates the tax consequences for both the buyer and seller. The goal is to obtain a fair compromise that has positive consequences for both the buyer and the seller to move forward and close the deal. Business owners should involve an experienced M&A accountant early on in the process to avoid unexpected tax consequences resulting from the sale of the business. Here are some thinking points:
- You are only taxed if there is a gain on the sale or if income is earned
- The capital gains tax rate is almost always lower than the 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
Corporate Stock
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 owner’s 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.
Accounts Receivable
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.
Inventory
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.
Goodwill
This asset class is commonly referred to as blue sky. It is the amount of money that is not necessarily 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.
Non-Compete Agreements
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 in their enforceability.
Summary
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.
| Asset Classification | Seller | Buyer |
| Accounts Receivable | Ordinary gain or loss to the extent the allocated value differs from the tax basis. | Ordinary gain or loss to the extent the collections differ from the allocated value. |
| Inventory | Ordinary gain or loss to the extent to allocated value differs from the seller’s cost. | Maybe capitalized and can impact earnings in the first year. |
| Real Property – Land | The capital gain tax rate | Capitalized |
| Real Property – Building | Capital Gain tax rate and may be subject to Depreciation Recapture | Depreciation |
| Personal Property – Furniture, Fixtures, & Equipment (FF&E) | Ordinary Income, Depreciation Recapture, or Section 1231 Loss treatment. | Capitalize and depreciate over the useful life of the asset. |
| Intangibles | Capital Gain tax rate. | Capitalize and amortize over 15 years. |
| Intellectual Property | Capital Gain tax rate. | Capitalize and amortize over legal life. |
| Goodwill | Capital Gain tax rate. | Capitalize and amortize over 15 years. |
| Consulting/Employment Agreements | Ordinary Income tax rate subject to FICA. | Current deduction (operating expense) |
| Non-Compete Agreements | Ordinary Income tax rate. | Capitalize and amortize over 15 years. |