Taxes on Structured Sales
Before I even get started, please understand that I do NOT practice public accounting. I am a CPA with over 20 years of experience but carry no liability insurance nor do I wish to be audited by the AICPA (American Institute of Certified Public Accountants) every few years. In short, the following is purely informative – you will want to engage a CPA to hammer out the details.
All of the above, however, does not prevent me from outlining various accounting scenarios involved in the sale and purchase of a business and their tax implications. A couple of immutable laws:
If you are selling a business and no shares were ever issued (i.e., it is not a Partnership, LLC, C- Corporation or S Corporation) but rather a sole proprietorship (Schedule C), your sale will be composed of the Fair Market Value (FMV) of all assets + goodwill.
In this case, all the depreciation you’ve reported on your tax return will be ‘recaptured’ at an ordinary income tax rate up to the agreed upon value of your assets rather than treatment as a capital gain.
You sell your business for $100,000 – the contract stipulates that the fair market value of the assets is $70,000.
You have depreciated all your assets to a book value of $0. All $70,000 is taxable as ordinary income.
Likewise, if you and the buyer valued the equipment at $40,000 – you would only report
$40,000 subject to taxation at an ordinary income rate.
Of course, the buyer would prefer that the FMV of all of the assets were as high as possible in order to begin enjoying the cash flow and tax advantages of depreciation.
The net difference between the selling price ($100,000) and the agreed upon FMV of the assets is considered Goodwill.
This amount would be reported by the owner as a capital gain and as an intangible asset by the buyer – subject to amortization over a 15 year period.
It doesn’t take a Jeopardy Final Contestant to recognize the import of how a purchase is structured to both the Buyer and Seller. By the way, corporations, LLC’s, and Partnerships can also sell in this manner – as long as they are not selling their entity as a whole.