The purpose of this article is to demonstrate the importance of the tax impact in the sale of your business. As an M&A intermediary and member of the IBBA, International Business Brokers Association, we recognize our responsibility to recommend that our clients use attorneys and tax accountants for independent advice on transactions.
As a general rule, buyers of businesses have already completed several transactions. They have a process and are surrounded by a team of experienced mergers and acquisitions professionals. Sellers on the other hand, sell a business only one time. Their “team” consists of their outside counsel who does general business law and their accountant who does their books and tax filings. It is important to note that the seller’s team may have little or no experience in a business sale transaction.
Another general rule is that a deal structure that favors a buyer from the tax perspective normally is detrimental to the seller’s tax situation and vice versa. For example, in allocating the purchase price in an asset sale, the buyer wants the fastest write-off possible. From a tax standpoint he would want to allocate as much of the transaction value to a consulting contract for the seller and equipment with a short depreciation period. A consulting contract is taxed to the seller as earned income, generally the highest possible tax rate. The difference between the depreciated tax basis of equipment and the amount of the purchase price allocated is taxed to the seller at the seller’s ordinary income tax rate. This is generally the second highest tax rate (no FICA due on this vs. earned income). The seller would prefer to have more of the purchase price allocated to goodwill, personal goodwill, and going concern value. The seller would be taxed at the more favorable individual capital gains rates for gains in these categories. An individual that was in the 40% income tax bracket would pay capital gains at a 20% rate. Note: an asset sale of a business will normally put a seller into the highest income tax bracket.
The buyer’s write-off period for goodwill, personal goodwill, and going concern value is fifteen years. This is far less desirable than the one or two years of expense “write-off” for a consulting agreement.