Tax Considerations In Selling a Business: What is Received and What is Kept

When selling a business, understanding the tax implications is crucial to ensure you retain the maximum proceeds after taxes. This discussion will cover the key tax considerations you need to be aware of, focusing on asset purchases, the typical structure of middle-market transactions, and the various tax treatments involved. Remember, it is always advisable to consult with your CPA or tax professional for specific advice tailored to your situation.

Tax Implications of a Business Exit

Understanding the Structure of Business Sales

A business can be acquired in two primary ways: through the purchase of the business’s assets or the purchase of its stock. In the middle and lower markets, asset purchases are more common. Therefore, this discussion will focus on the tax considerations related to asset purchases.

When you sell a business through an asset purchase, the buyer acquires specific assets and possibly some liabilities. The purchase price is then allocated among these assets, and this allocation determines the tax treatment of the proceeds.

Tax Implications of Different Assets

Furnishings, Fixtures, and Equipment (FF&E)

FF&E includes all the physical, tangible items used in the business, excluding inventory. When these assets are sold, they are typically taxed at ordinary income rates. This is because you can depreciate these assets over time, and the remaining undepreciated value is taxed as ordinary income upon sale. For example, if you sell machinery or office furniture, the proceeds beyond the depreciated amount will be taxed at your ordinary income rate.

Inventory

Inventory, which consists of the goods held for sale, is not subject to tax upon sale if it was purchased with after-tax money. For instance, if you run a distribution company and keep $2 million worth of inventory, this portion of the sale will not be taxed again.

Post-Transaction Obligations

These include non-compete agreements or any compensation for transition services post-sale. These payments are taxed at ordinary income rates, similar to how a salary or contractor payment would be treated. If you agree to a non-compete clause or stay on to help transition the business, the compensation you receive will be taxed as ordinary income.

Goodwill

Goodwill represents the business’s value beyond its tangible assets, such as brand reputation, customer relationships, and other intangible factors. The proceeds attributed to goodwill are subject to long-term capital gains tax, which is typically lower than ordinary income tax rates. For example, if the total sale price is $10 million, and after accounting for FF&E, inventory, and post-transaction obligations, $6.5 million is attributed to goodwill, this amount will be taxed at the long-term capital gains rate.

The Importance of Purchase Price Allocation

During the sale, the buyer and seller will negotiate how to allocate the purchase price among the various assets. This allocation significantly impacts the tax liabilities of both parties. Buyers may prefer to allocate more towards assets that offer quicker depreciation benefits, while sellers may aim to allocate more towards goodwill to benefit from lower capital gains tax rates.

Consulting with a CPA

Given the complexity of these transactions and the significant impact of tax implications, consulting with a CPA or tax professional is essential. They can provide detailed advice tailored to your specific situation and help you navigate the negotiation process to optimize your tax outcomes.

Summary

Understanding the tax implications of selling a business is essential to ensure you maximize your after-tax proceeds. Key considerations include the tax treatment of FF&E, inventory, post-transaction obligations, and goodwill. The allocation of the purchase price among these assets can significantly impact your tax liabilities, making it crucial to negotiate effectively and consult with a tax professional. By keeping these factors in mind, you can better prepare for a successful and financially optimized business sale.