Volume 21 Issue 4 -- July/August 2009
In the last two
issues, we have
been looking at issues relating to structuring a sale of a business as a stock
sale or as an asset sale. In this issue, we will conclude this series with some
suggestions for other aspects of the business sale, regardless of whether it is
a stock sale or an asset sale.
In that connection, Tax and
Business Professionals has developed over a 20-year period a Checklist For
Business Purchases or Sales that many have found valuable in formulating
their ideas about buying or selling businesses. Please contact us if you would
like a copy.
One feature of all business
sales agreements is payment provisions. It is important that the payment
provisions are consistent with the type of sale — sale of assets or sale of
interests in the business entity. In other words, the payment for an entity sale
must go to the entity owners, while payment for an asset sale must go to the
asset owner (the business entity).
Many small business sales
involve seller financing, where the buyer pays a portion of the purchase price
at closing and the balance through promissory notes. When the seller provides
financing, consideration must be given to the type and amount of security that
the seller will receive to secure the future payments. Security can take a
variety of forms, including personal guaranties, security interests in the
property sold or in other property, or stand-by letters of credit. What matters
is making sure that the seller is adequately protected in the event that the
Many business sales involve
contingent sales prices, where the total amount of the purchase price is tied to
some measure of the performance of the business after the sale closes. Such
arrangements can create a host of logistical and tax issues.
The manner of computing the
amount and timing of the payment of any contingent payment amount is very
important and must be structured carefully to coincide with the business’s
normal accounting practices. Particularly in asset sales, this may require that
the buyer place the purchased assets in a separate entity so that tracking the
business’s performance after the sale can be done more easily.
Contingent price arrangements
also can create some special and complex tax issues, if the seller plans to use
installment reporting. For example, suppose a business is to be sold for a
guaranteed price of $1 million, but with an additional $100,000 due each of
the next five years if certain performance targets are met. For tax purposes,
the sales price for computing any installment gain may be treated as $1.5
million, and, under some potentially complex rules, a portion of the “sales
price” may have to be treated as “interest.”
A typical business sale may also
include one or more covenants not to compete, under which the seller of the
business (and often its principals) will agree not to compete with the buyer for
a period of time, say, two years after the sale. Generally this is a good way to
protect the buyer.
the buyer will want to amortize the covenant payments, it is critical that the
amount of the purchase price allocated to the covenant be clearly stated. Also,
any individual seller will usually have to treat the receipt of such payments as
self-employment income, rather than as gain from the sale of the property.
It is common for buyers of
businesses to agree to hire or retain employees (or principals) of the business
to serve as employees or consultants after the sale closes, but it is usually a
mistake to include such employment arrangements in the business sale agreement
itself. The IRS could argue that the payments for the “services” are in
reality additional payments for the business. A far better practice is for the
buyer to enter into separate employment agreements with the employees or
principals with separate payment provisions not related to the sales agreement.
Particularly when pass-through
entities (S corporations, LLCs, and partnerships) are involved in asset
sales, it is important at the time of the asset sale to consider whether the
entity itself should be liquidated after the sale. Because any gain on the asset
sale at the entity level will pass through to the owners, this may create a
large amount of basis that the owners will recover only on liquidation of the
entity. Depending upon the circumstances, this may result in a large capital
loss that may be difficult for the owners to use fully. By liquidating the
entity in the same year as the sale, however, that loss can often be used to
offset some of the gain on the asset
sale and avoid mismatching the capital gains and losses.
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
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