Buying or selling a business is a complicated transaction with many tax, legal and financial variables to consider. Although the sale or purchase of a business should never be compelled by tax considerations alone, taxes can have a substantial impact. Questions such as, what are the goals of the buyer and the seller, how should the transaction be structured, what types of entities are involved, should all be well thought out.
There are two basic ways to purchase a business
- Asset Acquisition
- Stock / Ownership Interest Acquisition
Depending on the entity structure and certain circumstances of the buyers and sellers, either option may prove to be more beneficial. However, as with many business transactions, the buyer and seller don’t always agree. Buyers generally prefer to buy assets, while sellers generally prefer to sell stock, if possible.
Buyers generally prefer to buy assets because:
- Buyer is able to step up the basis of the assets to FMV which will increase future depreciation deductions, while the buyer in stock sale assumes the seller’s basis in the assets which may already be fully depreciated
- Buyer can choose which assets it wants
- Buyer does not need to assume the liabilities of the seller
Sellers generally prefer to sell stock because:
- Profits from a stock sale are generally taxed as capital gains at favorable rates while profits from an asset sale are taxed at capital gain rates or ordinary income rates depending on the purchase price allocation
- Asset sales for C-Corporations also result in double taxation as the profit from the asset sale is recognized and taxed at the corporate level and the liquidating distribution (if paid) is taxed at the shareholder level
Asset Acquisition
The tax implications for both the buyer and the seller depend on how the purchase price is allocated amongst various assets. This is a critical piece of the transaction and the buyer and seller must use the same allocation despite having opposing interests.
Buyer Considerations:
- The buyer wants to allocate as much purchase price as possible to short-lived assets as possible in order to receive larger deductions in the short-term
- Assets such as inventory and short-lived fixed assets such as equipment and furniture (5-7 years) are preferable for the seller as the deductions will be more immediate than allocating purchase price to a 15-year intangible or 39-year building
Seller Considerations:
- The seller wants to allocate as much purchase price as possible to assets that will give rise to capital gains as opposed to ordinary income
- Assets such as intangibles and goodwill result in capital gain for the seller which is taxed at preferential rates
- Assets including non-compete agreements are taxed as ordinary income, often much higher than the capital gains rate
Stock Acquisition
Buyer Considerations:
- Buyers receive basis of its purchase price for the stock
- No basis adjustment is made to the assets as they maintain a carryover basis
- The corporation’s tax attributes including NOL’s, credits, etc may be retained by the buyer
- Section 338 election is available to corporate buyers to treat a stock sale as an asset sale for tax purposes allowing for a step up in basis for the assets, however, the seller’s tax attributes disappear
Seller Considerations:
- Seller recognizes gain for difference between proceeds and tax basis
- Assuming stock was owned for over 12 months, gain is taxed at favorable capital gains rates
Taxes are just one piece of the puzzle when buying or selling your business and can significantly impact the resulting cash flow for both parties involved in the transaction. By understanding all of the economics of a deal, you can adjust the purchase price or terms of the deal as necessary.
If you are thinking of buying or selling a business contact a member of our team today to learn more about tax consideations and strategies.
