Tax Considerations for the Buyer - Asset Purchase

Once the purchase price has been determined, the general tax consequences to the buyer are determined by how the transaction is ultimately structured.  In accordance with IRC Sec. 1060, the purchase price must be allocated based on one set of fair market value considerations.  The allocation must be included in the transaction documents and reported to the Internal Revenue Service in the tax year of the transaction.  Form 8594 is used for reporting the transaction on the buyer and seller tax returns.  It is very important that there are no inconsistencies in the tax filings.

Temp. Reg. 1.1060-1T(c)(2) separates trade or business assets into seven classes:

I.               Cash and equivalents.

II.             Actively traded personal property defined in IRC 1092 (marketable securities) and certificate of deposits.

III.           Accounts receivable, mortgages and credit card receivables in the ordinary course of business.

IV.           Stock in trade or other property that would ordinarily be included as inventory.

V.             All assets not included in items I through IV above.

VI.           IRC Sec. 197 intangibles except goodwill.

VII.         Goodwill .

There is a significant amount of planning which can be done at this point in the transaction with regard to tax and accounting issues.  In reviewing the seven items in Temp. Reg. 1.1060-1T(c)(2), it is obvious that through planning and negotiation, the allocation of the purchase price can have a significant impact on the desired outcome of the transaction.  Once the asset purchase transaction is closed, the buyer has purchased a group of assets, which now have a new holding period.  The buyer must then make various tax elections for the treatment of depreciation and amortization.  As we have previously discussed, all other tax attributes remain with the seller in an asset purchase transaction.

Tax Considerations for the Seller - Asset Purchase

The sale of trade or business assets in an asset purchase transaction results in taxable gains and losses to the seller. Gain or loss will be determined on each individual class of assets sold.  It is important to again stress the importance of pre-planning with regard to structuring the allocation of purchase price in the transaction.  After the determination of gain or loss has been made, the gain or loss falls into the appropriate category to determine if the gain or loss will be capital gain/loss or an ordinary gain/loss.  Capital gains currently enjoy a maximum federal tax rate of 15 percent while ordinary gains are included in income and taxed at an individuals effective tax rate.  Capital losses are limited to $3,000 after netting against capital gains.  Ordinary losses are fully deductible in the year of loss.

Because of the many different forms of consideration, the seller must understand the consequences of accepting a cash deal, or seller-installment notes, or an earn out provision.  Allocation of the forms of consideration must also be pre-planned so that the seller achieves a desirable outcome.

The following tax planning pointers are recommended for sellers in an asset purchase transaction before settling on a final purchase price and consideration:

-       Consider any debt that must be paid off at closing.

-       Consider the form of consideration.

-       Consider the amount of cash desirable at closing.

-       Consider the tax consequences.

Tax Considerations - Stock Purchase

There are three ways to accomplish the sale of a business other than the sale of the individual assets.   

1. The stockholders of a corporation can dispose of their common interests through a taxable stock sale.  A taxable stock sale results in the target corporation remaining in existence with all tax attributes of the corporation residing with the corporation.  The individual stockholders will recognize gain on the sale of  their individual interests.  Generally there will be no corporate level tax unless an IRC Sec. 338 election applies.
   
2. The stockholders of a corporation can dispose of their common interests in a tax-free reorganization.  A tax-free reorganization generally results in no gain or loss to the selling stockholders.
   
3. The stockholders of a corporation can dispose of their stock through a forward cash merger.  For tax purposes, this type of transaction treats the target company as selling its assets to an acquiring company followed by a liquidation.

The focus of this section will be to expand on the taxable stock sale transaction and compare the different tax considerations to a direct asset sale.

Generally, when a corporation owns appreciated assets, a tax problem will exist for one of the two parties involved.  If a stock sale is executed, the deferred tax liabilities will be the buyer's problem moving forward.  If an asset sale is executed, the seller will usually have a current tax problem to deal with.

The importance of planning at this stage of the transaction, is to be creative enough so that the desired outcome for the buyer is also a positive for the seller.  This desired effect cannot always be accomplished.  Thus, the importance of having a good team working with the buyer and seller cannot be overstated.  The M&A professional understands the deal and will be able to help coordinate with the tax professionals the desired outcome of all parties.  All too often, the buyer's tax advisor will attempt to kill the deal because of the structure of the deal.  Or, the seller's tax advisor will attempt to alter the deal because the amount allocated to the non-competition agreement is too high.  The M&A professional can effectively manage and coordinate the deal so that the desired outcome for the buyer and seller can be realized.

Jeffrey J. Presogna is a CPA and CVA and has provided tax strategies, valuation, merger, and acquisition related services to a wide range of clients.  He is Managing Director of the Northeast office of Vercor.