When it comes to buying or selling a business, both the Buyer and Seller tend to focus primarily on the optimizing the price and terms. All too often negotiating the optimum allocation of purchase price is an after thought. In many cases it is not even discussed until months later when the tax returns must be filed, and at that point the Seller has almost no leverage.
Under IRS guidelines the total transaction price is to be allocated sequentially based on the fair market value of the acquired assets to the following seven asset classes: 1) cash and general deposit accounts, 2) actively traded securities, 3) other securities and accounts receivable, 4) inventory, 5) tangible personal property and real estate, 6) Section 197 intangible assets except for goodwill, and 7) goodwill and going concern value.
Each of these asset classes is treated somewhat differently from an expense, depreciation, and tax basis. Shifting the allocation in one direction or another can result in more of the proceeds being taxed at much higher ordinary income rates instead of more favorable capital gains rates. As a general rule, whatever is good for the Seller is typically bad for the Buyer, and vice versa. Since the IRS requires both the Buyer and Seller to use the same allocation when reporting the acquisition/sale on their respective tax returns (Form 8594), negotiating the optimum purchase price allocation can be as prickly as negotiating the purchase price and terms.
Since present and future tax implications can be very significant considerations for both the Buyer and Seller, negotiating and agreeing upon the purchase price allocation should be one of the next priorities after the price and terms of the sale have been agreed to. Ideally, it should be negotiated and agreed to in the Letter of Intent.
Here again, the Buyer and Seller will benefit from working with an experienced M&A advisor – as well as their respective tax and accounting advisors – as they work towards an optimum allocation that is fair to both parties.
If you know of a business owner who’s thinking of selling or buying a business and who might benefit from a free consultation with us, have them contact me, or any of the M&A professionals at www.transworldma.com.
Mike Ertel, CBI, M&AMI, CM&AA
Transworld M&A Advisors
© 2016, J. Michael Ertel, PA