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Considerations in Selling Your Business - Part 14: Tax Issues Part 4

by Patrick B. Mathis, Shareholder at Mathis, Marifian and Richter, Ltd.

Tax Issues - Part 4

Finally, in considering the potential tax implications of the sale of a business, sellers, and buyers, should be aware of the potential tax ramifications resulting from the allocation of the price beyond those related to the “stock vs. asset sale” issues discussed in earlier blogs.

shareholder

For example, if a shareholder has been actively engaged in business for many years and controls the majority of the corporation’s client accounts, and the buyer insists upon an asset purchase rather than a stock sale, the parties should carefully consider the economic realities related to the allocation of the amount to be paid. In that case, the buyer may wish to incorporate the selling shareholder’s continuing employment or consulting role in the business as an integral part of the overall purchase price. Consequently allocating a portion of the gross amount to be paid to the selling shareholder’s employment contract or consulting agreement will generate ordinary income to the seller but an immediate deduction to the buyer as the payments are made.

In many cases, the purchaser will also demand a covenant not to compete and some portion of the purchase price may be allocated as consideration for the covenant. Those allocated payments are generally deductible over a 15 year term by the buyer while being taxed as ordinary income to the seller.

In some instances a portion of the payments to a selling shareholder may be treated as personal goodwill, rather than goodwill of the corporation, because of the selling shareholder’s control of the accounts. In that case, the payment attributable to the personal goodwill may be taxed as a capital gain to the selling shareholder because his personal goodwill is treated as a capital asset for tax purposes.

A selling company may also wish to minimize the allocation of the sale price to equipment because of the potential impact of depreciation recapture to the LLC or S corporation, while a buyer wishes to allocate as much of the cost as possible to that equipment in order to take a short term depreciation deduction.

While these allocations are the frequent focus of discussions between buyers and sellers, the Internal Revenue Code and regulations require that there be a reasonable basis of allocation among various classes of assets involved in the sale transaction. Consequently, before entering into sale discussions, a seller should carefully consider the value of the enterprise and the range of valuation of the various components of the sale including inventory, equipment, goodwill and other intangible assets. The assistance of an appraiser, accountants or attorneys to evaluate and analyze the impact of varying sale structures can often yield significant benefits to the seller or buyer in these transactions.

Professional Services Disclaimer: Please note that the information presented here is as an educational service, and while it contains information about legal issues, it is not legal advice. No warranty is made regarding the applicability of the information presented to a particular client situation, and the information set forth is not a substitute for original legal research, analysis and drafting for a particular client situation.

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