Only If You Selling Your Business- Deal Structure and Taxes

Only If You Selling Your Business- Deal Structure and Taxes

The purpose of this article is to demonstrate the importance of the tax impact in the sale ofyour business. As an M&A intermediary and member of the IBBA, International Business Brokers Association, we recognize our responsibility to recommend that our clients use attorneys and tax accountants for independent advice on transactions.

As a general rule, buyers of businesses have already completed several transactions. They have a process and are surrounded by a team of experienced mergers and acquisitions professionals. Sellers on the other hand, sell a business only one time. Their "team" consists of their outside counsel who does general business law and their accountant who does their books and tax filings. It is important to note that the seller's team may have little or no experience in a business sale transaction.

Another general rule is that a deal structure that favors a buyer from the tax perspective normally is detrimental to the seller's tax situation and vice versa. For example, in allocating the purchase price in an asset sale, the buyer wants the fastest write-off possible. From a tax standpoint he would want to allocate as much of the transaction value to a consulting contract for the seller and equipment with a short depreciation period. 

A consulting contract is taxed to the seller as earned income, generally the highest possible tax rate. The difference between the depreciated tax basis of equipment and the amount of the purchase price allocated is taxed to the seller at the seller's ordinary income tax rate. This is generally the second highest tax rate (no FICA due on this vs. earned income). The seller would prefer to have more of the purchase price allocated to goodwill, personal goodwill, and going concern value. 

The seller would be taxed at the more favorable individual capital gains rates for gains in these categories. An individual that was in the 40% income tax bracket would pay capital gains at a 20% rate. Note: an asset sale of a business will normally put a seller into the highest income tax bracket.

The buyer's write-off period for goodwill, personal goodwill, and going concern value is fifteen years. This is far less desirable than the one or two years of expense "write-off" for a consulting agreement.

Another very important issue for tax purposes is whether the sale is a stock sale or an asset sale. Buyers generally prefer asset sales and sellers generally prefer stock sales. In an asset sale the buyer gets to take a step-up in basis for machinery and equipment. Let's say that the seller's depreciated value for the machinery and equipment were $600,000. FMV and purchase price allocation were $1.25 million. 

Under a stock sale the buyer inherits the historical depreciation structure for write-off. In an asset sale the buyer establishes the $1.25 million (stepped up value) as his basis for depreciation and gets the advantage of bigger write-offs for tax purposes.

The seller prefers a stock sale because the entire gain is taxed at the more favorable long-term capital gains rate. For an asset sale a portion of the gains will be taxed at the less favorable income tax rates. In the example above, the seller's tax liability for the machinery and equipment gain in an asset sale would be 40% of the $625,000 gain or $250,000. In a stock sale the tax liability for the same gain associated with the machinery and equipment is 20% of $625,000, or $125,000. 

The form of the seller's organization, for example C Corp, S Corp, or LLC are important to consider in a business sale. In a C Corp vs. an S Corp and LLC, the gains are subject to double taxation. In a C Corp sale the gain from the sale of assets is taxed at the corporate income tax rate. The remaining proceeds are distributed to the shareholders and the difference between the liquidation proceeds and the stockholder stock basis are taxed at the individual's long-term capital gains rate.

The gains have been taxed twice reducing the individual's after-tax proceeds. An S Corp or LLC sale results in gains being taxed only once using the tax profile of the individual stockholder.

Selling your business - tax consideration checklist:

1. Get good tax and legal counsel when you establish the initial form of your business - C Corp, S Corp, or LLC etc.

2. If you establish a C Corp, retain ownership of all appreciating assets outside of the corporation (land and buildings, patents, trademarks, franchise rights). Note: in a C Corp sale, there are no long-term capital gains tax rates only income tax rates. Long-term capital gains can only offset long-term capital losses. Personal assets sales can have favorable long-term capital gains treatment and you avoid double taxation for these assets with big gains.

3. Look first at the economics of the sales transaction and secondly at the tax structure.

4. Make sure your professional support team has deal making experience.

5. Before you take your business to the market, work with your professionals to understand your tax characteristics and how various deal structures will impact the after-tax sale proceeds

6. Before you complete your sales transaction work with a financial planning or tax planning professional to determine if there are strategies you can employ to defer or eliminate the payment of taxes.

7. Recognize that as a general rule your desire to "cash out" and receive all proceeds from your sale immediately will increase your tax liability.

8. Get your professionals involved early and keep them involved in analyzing various bids to determine your best offer.

Again, the purpose of this article was not to offer you tax advice (which I am not qualified to do). It was to alert you to the huge potential impact that the deal structure and taxes can have on the economics of your sales transaction and the importance of involving the right legal and tax professionals.

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Just All About Structure and Taxes

Just All About Structure and Taxes

The purpose of this article is to demonstrate the importance of the tax impact in the sale of your business. As an M&A intermediary and member of the IBBA, InternationalBusiness Brokers Association, we recognize our responsibility to recommend that our clients use attorneys and taxaccountants for independent advice on transactions.

As a general rule, buyers ofbusinesses have already completed several transactions. They have a process and are surrounded by a team of experienced mergers and acquisitions professionals. Sellers on the other hand, sell a business only one time. Their "team" consists of their outside counsel who does general business law and their accountant who does their books and tax filings. It is important to note that the seller's team may have little or no experience in a business sale transaction.

Another general rule is that a deal structure that favors a buyer from the tax perspective normally is detrimental to the seller's tax situation and vice versa. For example, in allocating the purchase price in an asset sale, the buyer wantsthe fastest write-off possible. From a tax standpoint he would want to allocate as much of the transaction value to a consulting contract for the seller and equipment with a short depreciation period.

A consulting contract is taxed to the seller as earned income, generally the highest possible tax rate. The difference between the depreciated tax basis of equipment and the amount of the purchase price allocated is taxed to the seller at the seller's ordinary income tax rate. This is generally the second highest tax rate (no FICA due on this vs. earned income). The seller would prefer to have more of the purchase price allocated to goodwill, personal goodwill, and going concern value.

The seller would be taxed at the more favorable individual capital gains rates for gains in these categories. An individual that was in the 40% income taxbracket would pay capital gains at a 20% rate. Note: an asset sale of a business will normally put a seller into the highest income tax bracket.

The buyer's write-off period for goodwill, personal goodwill, and going concern value is fifteen years. This is far less desirable than the one or two years of expense "write-off" for a consulting agreement.

Another very important issue for tax purposes is whether the sale is a stock sale or an asset sale. Buyers generally prefer asset sales and sellers generally prefer stock sales. In an asset sale the buyer gets to take a step-up in basis for machinery and equipment. Let's say that the seller's depreciated value for the machinery and equipment were $600,000. FMV and purchase price allocation were $1.25 million.

Under a stock sale the buyer inherits the historical depreciation structure for write-off. In an asset sale the buyer establishes the $1.25 million (stepped up value) as his basis for depreciation and gets the advantage of bigger write-offs for tax purposes.

The seller prefers a stock sale because the entire gain is taxed at the more favorable long-term capital gains rate. For an asset sale a portion of the gains will be taxed at the less favorable income tax rates. In the example above, the seller's tax liability for the machinery and equipment gain in an asset sale would be 40% of the $625,000 gain or $250,000. In a stock sale the tax liability for the same gain associated with the machinery and equipment is 20% of $625,000, or $125,000.

The form of the seller's organization, for example C Corp, S Corp, or LLC are important to consider in a business sale. In a C Corp vs. an S Corp and LLC, the gains are subject to double taxation. In a C Corp sale the gain from the sale of assets is taxed at the corporate income tax rate. The remaining proceeds are distributed to the shareholders and the difference between the liquidation proceeds and the stockholder stock basis are taxed at the individual's long-term capital gains rate.

The gains have been taxed twice reducing the individual's after-tax proceeds. An S Corp or LLC sale results in gains being taxed only once using the tax profile of the individual stockholder.

Selling your business - tax consideration checklist:

1. Get good tax and legal counsel when you establish the initial form of your business - C Corp, S Corp, or LLC etc.

2. If you establish a C Corp, retain ownership of all appreciating assets outside of the corporation (land and buildings, patents, trademarks, franchise rights). Note: in a C Corp sale, there are no long-term capital gains tax rates only income tax rates. Long-term capital gains can only offset long-term capital losses. Personal assets sales can have favorable long-term capital gains treatment and you avoid double taxation for these assets with big gains.

3. Look first at the economics of the sales transaction and secondly at the tax structure.

4. Make sure your professional support team has deal making experience.

5. Before you take your business to the market, work with your professionals to understand your tax characteristics and how various deal structures will impact the after-tax sale proceeds

6. Before you complete your sales transaction work with a financial planning or tax planning professional to determine if there are strategies you can employ to defer or eliminate the payment of taxes.

7. Recognize that as a general rule your desire to "cash out" and receive all proceeds from your sale immediately will increase your tax liability.

8. Get your professionals involved early and keep them involved in analyzing various bids to determine your best offer.

Again, the purpose of this article was not to offer you tax advice (which I am not qualified to do). It was to alert you to the huge potential impact that the deal structure and taxes can have on the economics of your sales transaction and the importance of involving the right legal and tax professionals.

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Your Own Small Business Tax Deduction Information

Your Own Small Business Tax Deduction Information

What are the expenses that qualify as a small business? It is never easy to interpret what those tax authorities are saying, right?

A means and way to reduce your expense in every small possible way to ensure cosseting measures. This deduction, according to Code 162 of Internal Revenue Service is allowed for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business".

Traveling expenses, entertainment expenses, rentals and allowances paid to employees are in the broader sense of expenses... 'Ordinary and necessary' isdefending by the IRS in their own way. Please do not maker the mistake of putting your personal expenses under the business head. And make sure your expenses are small and should be in proportion to the charge.

Do not, even remotely try to make payments to persons who are your relatives, they will suspect and monitor in a very close way.

So, what are the expenses that qualify for tax deduction? The vehicles that you use qualify for that and two ways can be used to calculate this. The first is the standard mileage method whereby the sum is deducted on the per mile formula devised by IRS. The second is the actual expense method under which you deduct the actual costs you have incurred in operating the vehicle. Include depreciations charges, plus your gas and maintenance bills under this method.

Entertainment of customers is a major head where you will be given the deductions and it is only up to 50%. Verify that the expense is related only to business and not for any social or personal purpose.

Current expenses like rent, office supplies, electricity etc. can be deducted from this year's expense and they form a huge chunk of your bill.

File all your bills and make sure you have them accounted for properly. The big brothers are really bad and never know what they are upto.if the government is allowing you to do things in a legal way, why not make the most of it.

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The Most You Need To Know About 401(k)

The Most You Need To Know About 401(k)

The 401(k) is a retirement plan implemented and provided to employees by their employer as a means to save for their retirement. Not only do many employers contribute to the employees 401(k) along with employee contributions (this is known as matching), but the contributions are pre-tax contributions; in other words the deduction is taken prior to calculating the state and federal taxes due on the wages. This helps not only the employee, but also the employer.

There are several variations of the 401(k) and depending upon your employer's status as a small business, and their ability to fund a 401(k), you may operate under a SIMPLE 401(k), a traditional 401(k), or The Safe Harbor 401(k). All the plans vary as to their contribution limits, the employers required matching contributions, and the level of administration and IRS reporting that must be factored into the plan upkeep. Let's take a look at each of the plans, and discuss some of the advantages and disadvantages of each.

The SIMPLE 401(k) is best suited for small businesses that have a reliable earnings stream. In other words, their cash flow and earnings level are fairly steady and reliable, and they want to establish an easily controlled method for providing for retirement funding. Quite often, many of the family members will participate in the 401(k) as a way to fund their own retirement, and offset some of the taxable income from the family business. The disadvantage in operating this type of retirement account lies in the fact that contributions made on behalf of the employee by the employer are not optional, and some form of contribution must be made each year.

The traditional 401(k) is the most often avoided plan by small to medium sized businesses, simply because of the massive reporting requirements, and the compliance testing that must be done each year. The administrative costs for the traditional 401(k) for a company of about 10 employees costs around $2000 per year to administer, and that doesn't include the setup costs or the costs of loan features. In addition to the optional features costs, there is the cost of offering many investment choices. Most of the 401(k) plans for small businesses that were surveyed had a much better rate of participation as well as lowered plan costs when only a few options were offered, instead of 10 or more.

The compliance testing that must be done with the traditional 401(k) are quite complex, and require much involvement by the accounting or payroll department of the business. Today, many small businesses outsource their payroll function, and include the 401(k) plan administration as one of the outsourced functions also. The greatest advantage to the small business is that the business is not required to contribute to the plan, unless there is a significant imbalance in the contributions of the highly compensated employees versus the lesser paid employees.

The Safe Harbor 401(k) is a spin-off of the traditional plan, except for the fact that there aren't all the compliance requirements and testing that must be completed each year. The Safe Harbor plan is best suited for the small business that has a steady revenue stream, and that is able to make a required contribution each year to the employee fund. The employer must make a 3% contribution to all employees who qualify for retirement funding, regardless of whether the employee makes a contribution; also, the employer contribution level for non-highly compensated employees must not differ more than 2% from the highly compensated employee contribution rate. In this manner, the employer is required to provide the same benefits for all employees, without all the compliance testing of the traditional plan. The Safe Harbor 401(k) is simple to set up, and can be accomplished within 30 days of the new year, and is simple to administer. The disadvantage to this plan is the required contribution rates, and if the business does not have a steady cash or revenue flow, it is not a recommended plan.

After examining the different plan options available for small to medium companies, there should be at least one that fits within any small businesses scope of operations. Providing retirement funding for small business family members, as well as all other employees is one of the greatest benefits a company can offer current and prospective employees.

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