Tax and Other Considerations When Buying or Selling a Business

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The decision to buy or sell a business should include an examination of the tax, legal, and business advantages and consequences, a delicate balance comparable to the decisions made in day-to-day business. These types of transactions usually involve a significant amount of negotiation. Though the buyer and the seller will each have different goals during the negotiation process, both parties will share a desire to arrive at an outcome that balances the economic benefits and costs associated with the transaction.

Typically, businesses are sold as a collection of related assets or at the entity level. An asset sale – an agreement to buy or sell individual business assets that make up a business – is most commonly utilized in smaller transactions. A stock sale – an agreement to transfer ownership at the entity level – is more relevant for larger businesses, as it does not require numerous separate conveyances of each individual asset because the title of each asset lies with the corporation.

The structure of the transaction produces important factors to be identified and considered. These include the amount of tax paid by the seller on any realized gain, the purchaser’s ability to step up the basis of the business assets, the continued existence of the business entity, and any related tax benefits (such as net operating loss carryovers), to name a few.

The negotiation process is necessarily detailed, since what is beneficial for the buyer is not always beneficial for the seller, and vice versa. The process will result in a purchase and sale agreement, and each decision should take into consideration federal and state/local tax laws, which can be numerous and often complex.

The purchase and sale agreement should identify items such as:

  • Allocation of Purchase Price: A discussion will need to occur with regard to how the purchase price will be allocated, since the allocation will determine the amount and type (i.e. capital vs. ordinary) of income tax the seller must pay on the sale, and also create tax consequences for the buyer.
  • Seller Financing: If both buyer and seller agree that the purchase price will be paid over an extended time period, the seller may be able to defer gain on the transaction until the payments are actually received by the seller. It is important to note that the deferral is not permissible with respect to any portion of the transaction that represents depreciation recapture or gain on ordinary income items, such as accounts receivable or inventory.
  • Earnout/Contingent Payments: The most common example of a contingent payment in a buy/sell transaction is an earnout provision, in which the final sales price will be dependent on the financial performance of the business after the sale. The earnout must be defined in the purchase/sale agreement, including the relevant details with regard to the payment schedule, calculation, etc.

This is not an all-encompassing list, but rather a snapshot of the many points of consideration in a business sale transaction. The decision to buy or sell a business is not one to be taken mildly, as the various components can have a significant impact on the net dollars for both buyer and seller. In the early stages of the decision process, care should be given to discuss the facts with a tax advisor to ensure proper consideration and guidance is given to all aspects of the transaction.

Lisa G. Pileggi can be reached at lpileggi@kmco.com or 215.441.4600.

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