Business sellers and buyers are often entrepreneurs who are proficient in a particular branch of management but are generally not tax experts. For this reason, it is always convenient that when deciding to buy or sell a business, the parties seek advice from a specialist on the subject.
Without intending to lecture on taxes, I will summarize below the most important tax aspects to consider in relation to the process of buying and selling a business. Let's start from the premise that the amount of tax that the seller will have to pay will depend on the discrimination that is made of the price at the closing of the sale, either in the form of ordinary income or as capital gains.
The IRS defines the different assets into which the purchase price of a business can be broken down for tax purposes according to the categories shown in the following table:
PURCHASE PRICE ALLOCATION BETWEEN IRS DEFINED ASSET CLASSES
| Asset Type | Description |
| Class I: Cash and bank accounts | All cash and bank balances that are transferred as part of the sale. |
| Class II: Financial Papers | The current market value of all government-backed certificates of deposit, foreign exchange and securities, and publicly traded shares to be transferred as part of the sale. |
| Class III: Credits | Accounts receivable and other debt instruments in favor of the business, if they are being transferred as part of the sale. |
| Class IV: Inventory and stocks in the trade | The value of inventories and stocks for sale or negotiation in the ordinary course of business. |
| Class V: Tangible assets | The value of the furnishings and fixtures, buildings, land, vehicles, and equipment that are being transferred as part of the sale. |
| Class VI: Intangible assets (excludes Goodwill) | The value of all non-physical assets of the business (not including goodwill or capital gains). Includes trained workforce; business books and records; operating systems and procedures or any other basis of information, process, design, pattern, know-how, formula or similar element; any franchise, Internet domain, trademark or trade name or other intellectual property rights; databases and confidential information of customers and suppliers; licenses, permits or other rights granted by a government entity; any agreement not to compete in connection with the acquisition of an interest in a business; and other assets that the IRS lists in the Form 8594 instructions. |
| Class VII: Goodwill | Goodwill or surplus value is a special type of intangible asset represented by the portion of the total value of the business that cannot be attributed to other productive, tangible or intangible assets. The value of the capital gain is determined by subtracting from the purchase price the sum of the values assigned to all other classes of assets. |
Source: https://www.irs.gov/pub/irs-pdf/i8594.pdf
The interest of the seller and the buyer are usually opposed when it comes to dismembering the purchase price into its different components. Thus, the seller will always want to privilege the amount corresponding to capital gains because they pay a lower interest rate than ordinary income.
The buyer, for his part, will be interested in the operation reflecting the maximum possible value for the tangible assets because they will allow him to establish his very convenient reserves for amortization and depreciation for tax purposes. This will improve the cash flow of the company during the first years.
The seller, when selling, will transfer a series of tangible and intangible assets such as those described in the table above. However, if the transaction involves the sale of company shares, this asset discrimination will not apply for IRS purposes. When it comes to a sale of assets, the purchase price must stipulate the nature of each of the transferred assets.
Once the operation is completed, the buyer may depreciate or amortize most of the assets that were transferred to him. The seller, for his part, will want to reflect the maximum value referring to long-term capital gains because the IRS imputes to these gains a lower rate than the rates assigned to short-term gains, that is, those applied to investments held for less than a year. The following table shows the difference between both approaches:
Tax Rates
| Income Range: Individual Taxpayer | Income Range: Joint Return Marriage | Long Term Capital Gains: Tax Rate | Short Term Capital Gains: Tax Rate |
| $ 0 - $ 9,325 | $ 0 - $ 18,650 | 0% | Present in several = 10% |
| $ 9,326 - $ 37,950 | $ 18,651 - $ 75,900 | 0% | Present in several = 15% |
| $ 37,951 - $ 91,900 | $ 75,901 - $ 153,100 | Present in several = 15% | Present in several = 25% |
| $ 91,901 - $ 191,650 | $ 153,101 - $ 233,350 | Present in several = 15% | Present in several = 28% |
| $ 191,651 - $ 416,700 | $ 233,351 - $ 416,700 | Present in several = 15% | Present in several = 33% |
| $ 416,701 - $ 418,400 | $ 416,701 - $ 470,700 | Present in several = 15% | Present in several = 35% |
| $418,401 and over | $470,701 and over | Present in several = 20% | Present in several = 39.6% |
Source:IRS
For these reasons, when talking about the closing price of a business sale transaction, it is of great importance that the parties evaluate the tax consequences derived from the discrimination of the items reflected in the closing document.
It is convenient to clarify that there are other tax variables that also affect business sales operations because, in addition to federal taxes, state and local tax burdens must be taken into account. Proper planning will always make it possible to minimize or postpone at least some of these taxes.
To conclude, it is pertinent to quote this timely phrase by Leonardo Del Vecchio: "I don't like to pay taxes, but I like to sleep at night"
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