Tax Connections Newsletter – Fall 2014
Buying or Selling a Business? What You Need to Know
Buying or selling a company can be a good move in the right circumstances, but it is essential to know what is involved. It is necessary to research a number of business and financial issues as well as certain legal matters. And, of course, there are numerous tax issues that simply cannot be ignored. This newsletter looks at determining a business structure and allocating the purchase price.
Thinking of buying a company? Good for you! But be sure you know what you are getting into. For example, you will need to research a number of business and financial issues as well as certain legal issues. And, of course, there are numerous tax issues that you simply cannot ignore. Here are just a few.
Determining the Business Structure
If the business being sold is a corporation, the parties can structure the deal as a stock sale or an asset sale. As a general rule, however, sellers prefer to sell stock, while buyers prefer to buy assets.
So, why would a seller prefer to sell stock? In general, it is because the shareholders’ profits on the sale are generally taxed as capital gains (usually at the favorable long-term rate). Profits from asset sales, on the other hand, are typically taxed as a combination of ordinary income and capital gains.
Moreover, an asset sale will generally cause C corporation sellers to be taxed twice. First, the corporation pays tax on any gains from the asset sale; then, the corporation’s shareholders pay tax on their gains when the corporation is liquidated (although it may be possible to defer the second tax by having the corporation hold and invest the sale proceeds).
Fortunately, double taxation generally is not a concern for an S corporation — unless it was originally organized as a C corporation and then later elected S status. In that case, depending on how much time has passed, there may be a double tax on assets that had built-in gains at the time of the S election.
Looking from the buyer’s perspective, purchasing assets is usually more desirable because its basis in assets for depreciation purposes is generally equal to the portion of the purchase price allocated to those assets, typically allowing for greater depreciation deductions. And if the buyer purchases stock, it assumes the seller’s basis in the corporation’s assets, which may already have been depreciated down to a small amount, or even zero, thereby providing little or even no tax benefit for the buyer.
Allocating the Purchase Price
In an asset sale, the tax implications for both buyer and seller depend on how the purchase price is allocated among various assets. The catch is that the buyer and seller must use the same allocation for tax purposes, yet they often have conflicting interests. The parties do have some leeway to negotiate the allocation, but the IRS may find the allocation to be unreasonable or bear little correlation to asset values and, thus, challenge it.
The seller will want to allocate as much of the purchase price as possible to assets that generate lower-taxed, long-term capital gains, such as goodwill or real property. However, this allocation is less desirable for the buyer because goodwill and certain other intangibles are amortized over 15 years and buildings are depreciated over several decades.
Buyers generally prefer to allocate as much of the purchase price as possible to assets that can be depreciated quickly, such as equipment, computers and vehicles. This poses a problem for sellers, however, because often these assets are already fully depreciated, and “recapture” of previous depreciation deductions is taxed at ordinary-income rates.
Understanding the Deal
There is much to consider when buying or selling a business. Fortunately, your tax advisor can help you make the best decisions regarding the structure of the deal. For more information, contact Rob Swenson at [email protected] or call him at 312.670.7444.
In this issue, “Tax Tips” reminds readers that generally, alimony is deductible by the payer and taxable to the recipient. It also points out that bonus plans need to be crafted carefully. For example, the popular year end tax-planning strategy of deducting bonuses in the year they are earned, but deferring payment to the following year, is not automatically available to all employers. And reducing withholdings or estimated tax payments for the remainder of 2014 may allow taxpayers to enjoy their 2014 “refund” now.
Do Not Get Trapped in the Alimony Gap
According to the Treasury Inspector General for Tax Administration (an IRS watchdog), there is a big discrepancy between deductions claimed by ex-spouses paying alimony and the alimony income reported by recipients. Generally, alimony is deductible by the payer and taxable to the recipient. However, property settlements and child support payments are neither deductible nor includable in income.
The IRS is looking at strategies for closing the alimony gap. If you are uncertain whether payments you are making or receiving constitute alimony or if you are not sure how your spouse is treating these payments for tax purposes, consult your tax advisor.
Year End Bonus Plans: Design with Care
A popular yearend tax-planning strategy for employers is to deduct bonuses in the year they are earned, but to defer payment to the following year. Many employers assume that they are eligible for the IRS rule that permits this strategy if bonuses are paid within 2½ months after the end of the tax year in which they are earned (by March 15 for a calendar-year taxpayer). But that is not always the case.
First, the strategy is available only to accrual-basis taxpayers. Cash-basis taxpayers must deduct bonuses in the year paid. Second, even businesses using the accrual method of accounting must meet certain requirements to deduct bonuses in the year earned, including the “all events” test.
Under that test, an accrued bonus is deductible when 1) all events have occurred to establish liability for the bonus, and 2) the amount of the bonus can be determined with reasonable accuracy.
Certain bonus plan design features may cause bonuses to not be deductible until paid. For example, if an employee who leaves the company before the payment date forfeits his or her bonus, you will not pass the all events test until the bonus is paid (unless forfeited bonuses are reallocated to other employees who remain with the company). Also, bonuses that are contingent on board approval or other events that take place after year end generally are not deductible until paid. Further, there are restrictions on deducting accrued bonuses to related parties.
How to Collect Your 2014 Refund Now
If you usually receive a large federal income tax refund, you are essentially making an interest-free loan to the IRS. Rather than wait until 2015, why not enjoy your “refund” now by reducing your withholdings or estimated tax payments for the remainder of 2014? It is particularly important to review your withholdings, and adjust them if necessary, when you experience a major life event, such as marriage, divorce, birth or adoption of a child, or if you or your spouse is laid off.
For questions on any of these Tax Tips, contact Rob Swenson at [email protected] or call him at 312.670.7444.
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