Taxation session

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TAXATION – BUYING & SELLING AN AGENCY

Presented by:Kevin W. Smith, CPA, CIC

Mystic Capital Advisors Group, LLCwww.mysticcapital.com

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TAX CONSIDERATIONS IN BUYING / SELLING AN AGENCY

Seller’s Goals – To maximize capital gains treatment & minimize ordinary income tax rates

Buyer’s Goals – To maximize deductions (amortization/depreciation)

Federal Tax Rates Individual CorporateOrdinary Income 39.6% 35%Capital Gain 15/20% 35%

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TRANSACTION STRUCTURE

Stock Sale

Asset Sale

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STOCK SALE

Seller’s Perspective‐ Favorable‐ Difference between proceeds & cost basis is subject to capital gain

Buyer’s Perspective‐ Poor‐ Buyer has basis in stock, but no depreciation &/or amortization‐ Buyer now assumes the Target’s liabilities

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ASSET SALE

Seller’s Perspective‐ Not as favorable due to the potential of ordinary income for a portion‐ Portion not subject to ordinary income tax would be capital gains‐ Potential for double taxation if the Seller is a “C” Corporation

Buyer’s Perspective‐ Favorable‐Will have basis in assets equal to purchase price allotment‐ Purchase price is allotted among fixed assets and intangible assets‐ Fixed assets are depreciated over the estimated useful lives (per IRS)‐ Goodwill is amortizable over 15 years‐ Buyer is not responsible for Seller’s liabilities

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STOCK SALE (BOTH “S” & “C” CORPORATIONS) – ILLUSTRATION

Seller’s Perspective

Proceeds $5,000,000Less: Basis (500,000)

Gain on Sale $4,500,000Capital Gains – 20% 20%

Capital Gains Tax $ 900,000

Buyer’s Perspective‐ Basis ‐ $5,000,000‐ No future deduction for amortization &/or depreciation

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ASSET SALE ( “C” CORPORATIONS) – ILLUSTRATION Seller’s Perspective

Proceeds $5,000,000Less: Corporate Basis (1,900,000)

Gain on Sale $3,100,000Corporate Gain on Sale 35%

Corporate Tax $1,085,000

Cash Distributed to Shareholder $3,915,000Less: Basis (500,000)

Individual Gain on Sale $3,415,000Capital Gains Tax on Sale 20%

Capital Gains Tax – Individual $ 683,000

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ASSET SALE ( “C” CORPORATIONS) – Continued

Asset Sale –Corporate $1,085,000Individual 683,000

Total Tax Paid $1,768,000

Stock Sale –Individual $ 900,000

Thus, the Asset Sale resulted in an ADDITIONAL $868,000 in tax paid by the Seller.

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“C” CORPORATION ALTERNATIVE (STOCK SALE)

Proceeds (85% of $5,000,000) $4,250,000Less: Basis (500,000)

Gain on Sale $3,750,000Capital Gains – 20% 20%

Capital Gains Tax $ 750,000

Asset Sale –Proceeds $5,000,000Total Tax 1,768,000

Net Proceeds $3,232,000 Stock Sale –

Proceeds $4,250,000

Total Tax 750,000Net Proceeds $3,500,000

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ASSET SALE – S CORPORATIONS Favorable – See previous example

Must attach Form 8594 by the Buyer & Seller (Purchase Price Allocation)‐Must agree in between the Buyer & the Seller

Must have always been an “S” Corporation or have met the time threshold for conversion

Tangible Assets, Covenant Not to Compete & Goodwill

Covenant Not to Compete‐ Seller – Ordinary Income (not subject to Self‐Employment Tax)‐ Buyer – Amortized over 15 years (even if the underlying term is shorter)

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PERSONAL GOODWILL – A POTENTIAL ALTERNATIVE

Value of the business is attributable to the Principal & not the Company‐ Requires documentation of the business relationships being with Owner‐ Requires the services of a Valuation Expert to quantify the Personal GW

Tax Effects to Seller‐ Goodwill attributable to the Principal is NOT subject to corporate tax‐ Personal Goodwill is taxed to the Principal at capital gains rates‐ Goodwill attributable to the Company is subject to TWO levels of tax

Tax Effects to Buyer‐ No difference‐ Goodwill is amortized over 15 years, regardless of where attributed

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“S” CORPORATION CONVERSION May convert from a “C” Corporation to an “S” Corporation (Form 2553)

Generally, to achieve the full benefits of the conversion, must have made the election at least 10 years prior to the date of the transaction

If less than 10 years, subject to the Built‐In Gains Tax (essentially the difference between the fair market value of the Company’s assets on the day the election is effective & their tax basis)

Value in excess of the Conversion / Valuation date is not subject to the Built‐In Gains Tax, but rate simply individual capital gains tax

Valuation of assets as of the effective date of the “S” Election (if not, run the risk of the full amount being subject to the Built‐In Gains tax)

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INSTALLMENT SALES Installment Sale

‐ Sale of a business over time‐ Seller recognizes gain as the payments are made‐ Exception – Depreciation recapture must be reported in the year of sale‐ Depreciation Recapture = Ordinary Income

Seller’s Perspective –‐ Capital gain as payments are received based upon the gross profit %‐ Exception – Depreciation Recapture

Buyer’s Perspective –‐ Purchase price is allocated in the same manner as an all cash deal

Interest – Must be stated in the agreement, or it will be imputed‐ Purchase price is allocated in the same manner as an all cash deal

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SECTION 338(h)(10)

Stock is purchased, but the transaction is treated as if assets were purchased

Only available to corporations filing consolidated returns and to “S” Corporations

Same tax effects as an Asset Purchase

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WRAP UP Goal = One level of tax.

If not already an “S” Corporation, make the S Election & start the clock running on the 10‐year window

Sell stock when possible (although generally less feasible)

Minimize amounts subject to ordinary income tax rates, such as covenants not to compete and consulting agreements

Buyers – Strong preference to purchase assets, not stock, which results in depreciation/amortization of the purchase price

Taxation session

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