By LISA MONTI
Owners thinking about selling their businesses should consider taxes well before the deal is done, say attorneys who specialize in the process.
“Generally, the first thing that an owner contemplating the sale of his business would want to do is to meet with his or her competent business and tax adviser to discuss goals and structuring alternatives. Early in this process, the owner and his counsel should focus on several relevant considerations such as the type of entity being sold, or whether the owner desires to stay involved in the business after the sale,” said Tyler Ball, an attorney in the tax group of Baker Donelson in Jackson.
Attorney Jeramie Fortenberry, the founder and managing member of Fortenberry Legal, which has offices in Gulfport and Austin, Texas, said in an email response that there are a couple of ways to structure the sale.
“First, the parties could structure it as a sale of the equity of the business,” he said. For a corporation, that means that the sellers would be shareholders of the corporation and would be selling their corporate stock to the buyer. If the business is organized as an LLC, the sellers would be the members and the equity would be the membership interest in the LLC. In each case, the buyer is acquiring the equity of the company.”
The second option is an asset sale. “In this scenario, the seller is the company itself not the owners. The buyer would simply purchase all of the assets needed to run the business. The owners of the selling company would still own the equity of the company after the sale, but the company would no longer own the assets that are sold to the buyer,” Fortenberry said.
Sellers often prefer to sell the equity in the company, especially if the company is organized as a corporation that is taxed as a C corporation, said Fortenberry. In that situation, selling the stock of the corporation allows the sellers to pay only a single level of tax, thereby eliminating the problem of double taxation. “But the buyer will lose the benefit of a basis step-up on the underlying assets of the company. This means that the buyer will not be able to maximize the depreciation deductions that the buyer may otherwise be able to take on the assets of the company,” he said. “There are some circumstances where a buyer can elect to step up basis in this context, but that requires the company to immediately recognize the full gain in the assets.”
Buyers, the attorneys said, will typically prefer asset sales. “Asset sales allow the buyer to get a cost basis in the purchased assets. This cost basis erases any previous gain and gives the buyer the full benefit of any depreciation deductions. If the seller is taxed as a partnership or S corporation, or is disregarded for tax purposes, this may not be a significant issue for the seller. But if the seller is taxed as a C corporation, the proceeds from the sale would be taxed twice to the seller (once at the time of the sale, and again when distributions are made to the owners,” said Fortenberry.
Allocation of the purchase price is another concern for asset sales, said Fortenberry. The seller may request that the purchase price be allocated to assets with the highest basis to minimize tax on the sale.
“The seller may also want to allocate the purchase price to assets that will be taxed at preferential capital gains rates instead of being taxed as ordinary income. These goals may conflict with the goals of the buyer, who will want to allocate the purchase price to inventory or other assets that can be depreciated most quickly. The allocation of purchase price is often negotiated between buyer and seller and memorialized in a tax allocation agreement,” said Fortenberry.
Ball said that in some cases, there is an option for structuring the transaction in a tax-free or deferred manner, which could include the seller accepting some form of equity in the purchasing company or delaying receipt of some of the purchase price until a later tax year.
“It is not uncommon for a seller to take some cash as well as either receive some interest in the purchasing entity or retain an interest in the company being sold,” Ball said. “In many deals a buyer may desire to have the seller stay on and actively participate to insure the company’s continued success.”
Often the seller may stay only for a short term just to help with the transition. “Other times a buyer may want to keep the seller involved for a longer period if he or she has personal relationships with key customers or vendors or there is otherwise significant goodwill associated directly with the seller,” Ball said.
Ball said that sellers should, however, be careful not to let the tail wag the dog. “Although a seller should never underestimate the value of good, efficient tax planning, the economics of the deal are still in control,” he said. “Every seller needs to make sure he or she understands the net effect of the transaction as it’s being structured.”