Let’s say you have built a successful business and are now considering selling it. You have been approached by a company that wants to acquire the assets of the business as opposed to a stock acquisition. If the business is formed as a partnership, an LLC treated as a partnership, or an S corporation, no problem. The gain on sale of the assets will generally be taxed only once – at the individual level. But your business happens to be formed as a corporation (or an LLC treated as a corporation). This is potentially a big problem – gain on sale of the assets is taxed once at the corporate level and then again at the individual level. Is there anything that can be done to alleviate the double tax?
One potential solution is to consider whether there is any personal goodwill of the business owner(s) that is being sold. If the owner has significant industry experience and customer acquisition and retention is based on the owner’s skills and personal relationships with customers, it may be possible to allocate a portion of the selling price directly to the owner. This recognizes that a portion of the assets to be sold represent an asset of the owner(s) – personal goodwill. One of the leading tax cases in this area is Martin Ice Cream Company v. Commissioner (110 TC No. 18). Here the Tax Court found that much of the selling price was for assets not owned by the company, but rather, assets (personal goodwill) of the owner.
The determination as to whether personal goodwill exists in any given case is dependent on the specific facts of each business. Broad generalizations are not very useful. In addition to the question of personal goodwill, consideration should also be given to the value of any non-compete covenant that is expected to be part of the transaction, both corporate and individual. An experienced, qualified business appraiser should be consulted on these matters and a formal appraisal may represent cheap “insurance.”
By Steve Koons, CPA, ABV, ASA, CFF