Taking the time to research the financing and tax implications of a sale can provide you with a strong advantage come negotiation time.
Before you can understand the importance of negotiating a final small business sale agreement, it pays to brush up on facts about how sales are financed and how proceeds are taxed. Why? Because every decision regarding the payment structure affects when and how money transfers from the buyer to the seller and how the payments are taxed.
No one is asking you to become a financing or tax pro. That's what your sale advisors do, and you'll want to call on their advice through every step from here through to the closing of your deal and the transition of your business to its new owner.
But knowing some basic information will help you understand the advice you're receiving from those who are trained and up-to-date on the legal, financial, and tax implications of small business sales.
This topic is particularly important today with the pending debate on whether the Bush-era tax cuts will be extended beyond the end of 2012.
Step 1. Understand the implications of each purchase-payment approach.
Each payment approach provides either you or the buyer - but rarely both of you - an advantage, which means every decision translates to a financial benefit to one or the other, and therefore a point of negotiation.
The following provides an overview of the approaches for funding and paying off small business purchases. Your broker or your accountant will be able to provide more in-depth information and descriptions for how the approaches affect your particular sale.
Home Equity Loan
Step 2. Understand the tax implications of how you receive and allocate purchase price payments.
Here's where your advice from your accountant can really pay off. Before agreeing to the payment approach and price allocation, be sure to get professional advice on the following topics:
- How you can qualify for tax deferrals by accepting part of the purchase price in installment payments over upcoming years and by allocating deferred payments to assets that will be taxed at capital gains rates.
- How you can allocate the purchase price among IRS-defined asset classes to avoid taxation at the highest rates. The IRS requires that you and the buyer both report the price allocation identically, using Form 8594. The allocation must follow IRS stipulations, and it also must win agreement from you and the buyer (second part of this sentence, after the comma seems awkward, redundant from previous sentence?). Price allocation becomes a point of negotiation because tax advantages hang in the balance. Some allocations will benefit you. Some will benefit the buyer. None benefit you both at once. Again, don't proceed without professional advice from your accountant.
ALLOCATING THE PURCHASE PRICE AMONG IRS-DEFINED ASSET CLASSES
Class I assets: Cash and general deposit accounts
All cash that is transferring as part of the sale.
Class II assets: Actively traded personal property
Class III assets: Accounts receivable and debt instruments
Class IV assets: Inventory and stock in trade
The value of inventory and stock, which must be defensible based on cost or fair market value. The buyer may want to allocate as much as possible to this asset class because it qualifies as a deductible business expense.
The value of the all the non-physical assets of your business (not including goodwill), such as workforce, business books and records, systems and procedures, intellectual property, customer lists, and other assets that the IRS details in Form 8594 instructions (see link on this page). Frequently intangible assets are purchased in return for a non-compete agreement and/or a personal services contract, each of which offer different tax implications. Payment for a personal services contract allows the buyer to deduct the price as a business expense, while it will be taxed as ordinary income on your return for the year the payment is received. Payment for a non-compete agreement must be amortized or deducted over 15 years even if the agreement is for a much shorter time period, making it less attractive to buyers but more attractive to sellers.
The value of goodwill is determined by math and negotiation. This asset class equals the purchase price minus the amount allocated to all other classes. You'll want to allocate as much as possible to goodwill because the proceeds will likely be taxed as capital gains.
The information contained herein is necessarily detailed and extremely important since taxes, and therefore net dollars to you as the seller, hang in the balance.