As professional tax advisers we are often asked to comment on the tax implications our clients will face if their business is sold. From an income tax perspective, the buyer and seller are typically faced with structuring the deal as a stock sale versus an asset sale. These two strategies can result in significant tax implications for the parties involved so it is important that all parties engage competent tax and legal counsel throughout this process.
When a stock sale is agreed upon, the buyer purchases the selling shareholders’ stock directly and acquires ownership in the entity. Buyers do not have the ability to step up the basis of the assets and do not get to restart depreciation. The tax basis of the assets at the time of sale, is the tax depreciation basis for the buyer – thus resulting in less tax depreciation/higher taxes for the buyer. Buyers also need to work closely with their legal counsel to understand if any corporate liability concerns exist within the entity being acquired. Any potential liabilities become the responsibility of the buyer if they are not outlined and clearly defined in the purchase agreement.
Sellers will generally prefer stock sales over asset sales because the proceeds received are taxed at the lower capital gain rates. There are also planning techniques your tax adviser can employ to ensure that any potential capital gains from the sale can be timed with any potential capital losses to generate a beneficial tax outcome in the year of sale. The lower capital gain rate assumes that your stock was held for longer than 12 months before being sold.
Alternatively, the deal can be structured as an asset sale. These results are completely different between buyer and seller from what was illustrated above. In an asset sale, the seller retains possession of the legal entity and the buyer acquires the individual assets of the entity. Purchase price allocations between buyer and seller will be negotiated and agreed upon. The buyer will generally want a significant amount of the purchase price allocated to shorter lived assets as this allows for the “purchase price basis step up” to be depreciated rapidly for tax purposes thus generating significant tax benefits in the first few years after acquisition. Legal counsel should also advise on the generally favorable release of liability claims that are given to the buyer in an asset sale.
Sellers will generally not be excited about structuring the deal as an asset sale. The only item that will be taxed at the favorable capital gain rates for the seller will be the amount allocated to the intangible asset – Goodwill. Significant ordinary income can be generated based on the purchase price allocated to the depreciable assets being sold. Often as part of the negotiations you will see the seller being compensated for the incremental tax cost of agreeing to the asset sale. Be certain to discuss these options with your tax adviser as you work through the sale negotiation process.
Always hire competent legal and tax counsel as soon as the initial agreement comes in the door. You have worked hard for this – don’t let your lasting memory be writing a check to the taxing authorities for something you were not prepared for.