Thinking about selling your business? Make sure you consider the tax issues.
Two important aspects in terms of tax planning as it relates to the mergers and acquisitions (M&A) process are compliance and tax minimization. A few strategies that are common are discussed below, but there are many others you should discuss with your tax professional.
With respect to compliance, most states have exemptions to sales tax on assets purchased pursuant to a bulk sale — meaning an asset sale (see below for more on an asset sale). However, many states require sales tax to be paid on motor vehicles purchased pursuant to a bulk sale. You need to check with your state to make sure you are in compliance and determine who will pay the sales tax: the buyer or the seller.
When structuring a deal as an asset purchase (see below), the IRS Form 8594 must be completed and attached to the tax returns of both the buyer and seller. This form provides the IRS with details of how assets were divided among different classes for purposes of depreciation, amortization, and ordinary vs. capital gain treatment. For the IRS to verify the purchase price allocation was made consistently for both the buyer and the seller, the form is to be filed by both and should reflect the same allocations.
The overarching theme when it comes to minimizing taxes relates to capital gains vs. ordinary income. Long-term capital gains are taxed at a lower rate (minimum 0 percent, maximum 20 percent). Capital gains apply to sales of capital assets that are held longer than one year.
Ordinary income can be taxed as high as 37 percent federally, plus state taxes. While it’s easy to see why a seller would want a capital gain, a buyer would want deductions related to the sale at ordinary rates to reduce as much ordinary income for monies expended as part and parcel of the purchase.
This is where proper planning and negotiation between the buyer and the seller become important in reducing the tax burden of the seller while giving the buyer the maximum amount of tax benefit.
Asset sale vs. stock sale
In purchases and sales of companies, there are two main methods of structuring a deal. Depending on the objectives of the buyer and the seller, and after considering tax and legal alternatives, the parties will agree to either an asset deal or a stock deal. In our industry, most deals are asset deals, as they reduce legal liability to the purchaser and allow tax benefits to be shared by both the buyer and the seller.
In an asset sale, the assets of the company are sold to the buyer as opposed to the sale of ownership (stock) of the company. Included in the typical assets purchased category are trucks, cars, equipment, inventory, supplies, computers, furniture and fixtures, customer list, internet domain names as well as phone and fax numbers. While all these items get sold to the buyer, the seller is left with the corporation or limited liability company (LLC) that can either be used for another business or can be dissolved once the deal is completed.
By contrast, in a stock deal, the seller sells the stock or ownership in the corporation or LLC and passes the entire entity to the buyer.
Tax benefits in an asset deal
The tax benefits in an asset deal can be split between the buyer and the seller as agreed because the seller is interested in all gains being long-term capital gains, and the buyer is interested in deducting as much of the purchase price as quickly as possible at ordinary rates. This can be accomplished by allocating a large portion of the purchase price to assets that can be depreciated quickly, as well as creating employment or consulting agreements with the seller that result in ordinary deductions to the buyer.
Asset deals afford this capital gain pass-through only with S Corporations and other pass-through entities. If you are a C Corporation making an asset deal, the entire gain will be ordinary, which is highly inefficient. But there are other strategies that can soften the blow if you are a C Corporation; check with your tax advisor.
Tax benefits in a stock deal
The tax benefits in a stock deal are mainly for the seller because the seller receives capital gains treatment as if he or she sold the stock in the stock market. The buyer must capitalize the purchase price as part of a cost basis for the shares acquired and can be used to reduce the gain when the shares are resold. Because there is very little tax benefit the buyer can derive from this type of sale, it usually takes more cash outlay for the buyer to pursue this type of transaction.
Seek advice early
When looking to buy or sell a business, it’s not the price you receive as the seller or the price you pay as the purchaser that is as important as the amount you keep or the amount you pay after tax benefits.
If you are in the M&A game and you have identified a potential deal, it is always advisable to consult with your tax advisors early in the sale process.