Selling Your Business - Deal Structure and Taxes

The purpose of this article is to demonstrate themore favorable long-term capital gains rate. For
importance of the tax impact in the sale of youran asset sale a portion of the gains will be taxed
business. As an M&A intermediary and memberat the less favorable income tax rates. In the
of the IBBA, International Business Brokersexample above, the seller's tax liability for the
Association, we recognize our responsibility tomachinery and equipment gain in an asset sale
recommend that our clients use attorneys andwould be 40% of the $625,000 gain or $250,000.
tax accountants for independent advice onIn a stock sale the tax liability for the same gain
transactions.As a general rule, buyers ofassociated with the machinery and equipment is
businesses have already completed several20% of $625,000, or $125,000.The form of the
transactions. They have a process and areseller's organization, for example C Corp, S Corp,
surrounded by a team of experienced mergersor LLC are important to consider in a business
and acquisitions professionals. Sellers on the othersale. In a C Corp vs. an S Corp and LLC, the gains
hand, sell a business only one time. Their "team"are subject to double taxation. In a C Corp sale
consists of their outside counsel who does generalthe gain from the sale of assets is taxed at the
business law and their accountant who does theircorporate income tax rate. The remaining
books and tax filings. It is important to note thatproceeds are distributed to the shareholders and
the seller's team may have little or no experiencethe difference between the liquidation proceeds
in a business sale transaction.Another general ruleand the stockholder stock basis are taxed at the
is that a deal structure that favors a buyer fromindividual's long-term capital gains rate.The gains
the tax perspective normally is detrimental to thehave been taxed twice reducing the individual's
seller's tax situation and vice versa. For example,after-tax proceeds. An S Corp or LLC sale results
in allocating the purchase price in an asset sale,in gains being taxed only once using the tax profile
the buyer wants the fastest write-off possible.of the individual stockholder.Selling your business -
From a tax standpoint he would want to allocatetax consideration checklist:1. Get good tax and
as much of the transaction value to a consultinglegal counsel when you establish the initial form of
contract for the seller and equipment with a shortyour business - C Corp, S Corp, or LLC etc.2. If
depreciation period.A consulting contract is taxedyou establish a C Corp, retain ownership of all
to the seller as earned income, generally theappreciating assets outside of the corporation
highest possible tax rate. The difference between(land and buildings, patents, trademarks, franchise
the depreciated tax basis of equipment and therights). Note: in a C Corp sale, there are no
amount of the purchase price allocated is taxedlong-term capital gains tax rates only income tax
to the seller at the seller's ordinary income taxrates. Long-term capital gains can only offset
rate. This is generally the second highest tax ratelong-term capital losses. Personal assets sales can
(no FICA due on this vs. earned income). Thehave favorable long-term capital gains treatment
seller would prefer to have more of the purchaseand you avoid double taxation for these assets
price allocated to goodwill, personal goodwill, andwith big gains.3. Look first at the economics of
going concern value.The seller would be taxed atthe sales transaction and secondly at the tax
the more favorable individual capital gains ratesstructure.4. Make sure your professional support
for gains in these categories. An individual thatteam has deal making experience.5. Before you
was in the 40% income tax bracket would paytake your business to the market, work with
capital gains at a 20% rate. Note: an asset sale ofyour professionals to understand your tax
a business will normally put a seller into the highestcharacteristics and how various deal structures will
income tax bracket.The buyer's write-off periodimpact the after-tax sale proceeds6. Before you
for goodwill, personal goodwill, and going concerncomplete your sales transaction work with a
value is fifteen years. This is far less desirablefinancial planning or tax planning professional to
than the one or two years of expense "write-off"determine if there are strategies you can employ
for a consulting agreement.Another veryto defer or eliminate the payment of taxes.7.
important issue for tax purposes is whether theRecognize that as a general rule your desire to
sale is a stock sale or an asset sale. Buyers"cash out" and receive all proceeds from your sale
generally prefer asset sales and sellers generallyimmediately will increase your tax liability.8. Get
prefer stock sales. In an asset sale the buyeryour professionals involved early and keep them
gets to take a step-up in basis for machinery andinvolved in analyzing various bids to determine
equipment. Let's say that the seller's depreciatedyour best offer.Again, the purpose of this article
value for the machinery and equipment werewas not to offer you tax advice (which I am not
$600,000. FMV and purchase price allocation werequalified to do). It was to alert you to the huge
$1.25 million.Under a stock sale the buyer inheritspotential impact that the deal structure and taxes
the historical depreciation structure for write-off.can have on the economics of your sales
In an asset sale the buyer establishes the $1.25transaction and the importance of involving the
million (stepped up value) as his basis forright legal and tax professionals.Dave Kauppi is a
depreciation and gets the advantage of biggerbusiness broker and President of MidMarket
write-offs for tax purposes.The seller prefers aCapital. We help business owners with all aspects
stock sale because the entire gain is taxed at theof Mergers and Acquisitions.