Considerations In Selling A Business
purpose of this article is to demonstrate the importance
of the tax impact in the sale of a business. As a Merger
& Acquisition intermediary, we recognize our responsibility
to recommend that our clients use attorneys and tax accountants
for independent advice on transactions.
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.
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).
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.
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.
very important issue for tax purposes is whether the sale
is a stock sale or an asset sale. Buyers generally prefer
asset sales and sellers generally prefer stock sales. In
an asset sale the buyer gets to take a step-up in basis
for machinery and equipment. Let's say that the seller's
depreciated value for the machinery and equipment were $600,000.
FMV and purchase price allocation were $1.25 million. Under
a stock sale the buyer inherits the historical depreciation
structure for write-off. In an asset sale the buyer establishes
the $1.25 million (stepped up value) as his basis for depreciation
and gets the advantage of bigger write-offs for tax purposes.
seller prefers a stock sale because the entire gain is taxed
at the more favorable long-term capital gains rate. For
an asset sale a portion of the gains will be taxed at the
less favorable income tax rates. In the example above, the
seller's tax liability for the machinery and equipment gain
in an asset sale would be 40% of the $625,000 gain or $250,000.
In a stock sale the tax liability for the same gain associated
with the machinery and equipment is 20% of $625,000, or
The form of the seller's organization, for example C Corp,
S Corp, or LLC are important to consider in a business sale.
In a C Corp vs. an S Corp and LLC, the gains are subject
to double taxation. In a C Corp sale the gain from the sale
of assets is taxed at the corporate income tax rate. The
remaining proceeds are distributed to the shareholders and
the difference between the liquidation proceeds and the
stockholder stock basis are taxed at the individualÕs long-term
capital gains rate. The gains have been taxed twice reducing
the individual's after-tax proceeds. An S Corp or LLC sale
results in gains being taxed only once using the tax profile
of the individual stockholder.
your business - tax consideration checklist:
good tax and legal counsel when you establish the
initial form of your business C Corp, S Corp,
or LLC etc.
you establish a C Corp, retain ownership of all appreciating
assets outside of the corporation (land and buildings,
patents, trademarks, franchise rights). Note: in a
C Corp sale, there are no long-term capital gains
tax rates only income tax rates. Long-term capital
gains can only offset long-term capital losses. Personal
assets sales can have favorable long-term capital
gains treatment and you avoid double taxation for
these assets with big gains.
first at the economics of the sales transaction and
secondly at the tax structure.
sure your professional support team has deal making
you take your business to the market, work with your
professionals to understand your tax characteristics
and how various deal structures will impact the after-tax
you complete your sales transaction work with a financial
planning or tax planning professional to determine
if there are strategies you can employ to defer or
eliminate the payment of taxes.
that as a general rule your desire to "cash out"
and receive all proceeds from your sale immediately
will increase your tax liability.
your professionals involved early and keep them involved
in analyzing various bids to determine your best offer.
Again, the purpose of this article was not to offer you
tax advice, which Westmount M&A is not qualified to give.
It was to alert you to the huge potential impact that the
deal structure and taxes can have on the economics of your
sales transaction and the importance of involving the right
legal and tax professionals.