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Considerations In Buying/SellingAn Agency

Presented By: Jerry Bobal, CPA, M.S.WeiserMazars LLP

399 Thornall StreetEdison, NJ 08837

(732) 549-2800

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Goals of Seller – Maximize capital gains, minimize ordinary income

• Goals of Buyer – Maximize deductions (amortization/depreciation)

• Federal Tax Rates: Individual Corporation– Ordinary income 39.6% 35%– Capital gain 15/20.0% 35%

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Tax Considerations in Buying/Selling An Agency• Principal Methods of Disposition

1. Stock sale2. Asset sale

• Stock Sale:

Sellers Perspective – FavorableDifference between proceeds and cost basis is capital gain.

• Buyer’s Perspective ‐ PoorBuyer has a basis in stock for amounts paid but no depreciation or amortization deduction.  In addition, by purchasing stock, the buyer assumes the target’s liabilities.

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Tax Considerations in Buying/Selling An Agency• Asset Sale:

• Sellers Perspective – Not as favorable, due to potential of ordinary income for part ofthe sale and capital gain for the rest. Potential for double taxation if seller is a “C”corporation. Seller must also use proceeds to satisfy its liabilities.

• Buyer’s Perspective ‐ FavorableBuyer will have a basis in assets equal to the amount of the purchase price allocated,i.e. fixed assets, intangible assets, such as goodwill. Fixed assets are depreciated overtheir assigned lives per IRS tables. Goodwill is amortizable over 15 years. Buyer is notresponsible for sellers liabilities.

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Comparison of Stock Sale vs. Asset Sale

Cutler Corp. wishes to acquire the business of Kane, Inc. (a “C” corp). Assume that thevalue of Kane, Inc. is $5,000,000 and that the sole shareholder of Kane has a basis of$500,000 in his stock. The tax effects of the transaction are as follows:

• Stock Sale:

To Seller:

Proceeds $5,000,000Basis (500,000)Gain $4,500,000Capital gain tax (20%) $ 900,000

To Buyer:Basis in Kane, Inc. ‐ $5,000,000No future deduction for amortization or depreciation.

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Asset Sale

Assume the same facts above except that Cutler Corp. wants to purchase the assets ofKane, Inc. Kane, Inc. has the following balance sheet:

Adjusted Fair MarketBasis Value

Premiums receivable $3,600,000 $3,600,000Fixed assets (net of accumulateddepreciation of $100,000) 200,000 300,000Goodwill ‐ _3,000,000

Total Assets $3,800,000 $6,900,000

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Liabilities

Adjusted Fair MarketBasis Value

Accounts payable $ 900,000 $ 900,000Notes payable 1,000,000 1,000,000

Total Liabilities 1,900,000 1,900,000

Capital stock 500,000 3,600,000Retained earnings 1,400,000 1,400,000

1,900,000 5,000,000

$3,800,000 $6,900,000

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Corporate Gain on Sale:

Proceeds:Premiums receivable $3,600,000Fixed assets 300,000Goodwill 3,000,000 $6,900,000

Basis in Assets:Premiums receivable 3,600,000Fixed assets 200,000 3,800,000

Gain $3,100,000

Tax 35% $1,085,000

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Individual Gain on Liquidation:

Cash $6,900,000

Less: Liabilities 1,900,000Tax (corporate) 1,085,000 2,985,000

Cash distributed to shareholder 3,915,000Basis (500,000)Gain 3,415,000

Tax Capital Gain 20.0% 683,000

Net cash to shareholder $ 2,732,000

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Tax Comparison:

Asset sale –Corporate $1,085,000Individual 683,000

1,768,000Stock sale ‐ 900,000

Additional tax paid with asset sale $ 868,000

• Tax Effects to Buyer:Buyer will pay no tax on the collection of the accounts receivable. Buyer will depreciatefixed assets over IRS Life (typically 5‐7 years for office fixtures and equipment). Buyer willamortize $3,000,000 of goodwill over 15 years ($200,000 per year).

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An Agency• Variation:

What is we were able to attribute the goodwill of the business not to the corporation butto the owner? This would require documenting that the business relationships withcustomers were attributable to the owner personally. This would require the services of avaluation expert to quantify that personal goodwill.

• Tax Effects to Seller:To the extent goodwill is attributable to the individual and not to the corporation,corporate level tax is saved (but will be taxed to the individual at capital gain rates).

• Tax Effects to Buyer:No difference – Goodwill is amortized over 15 years whether attributed to individual orcorporation.

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w w w . M e r g e r s A n d A c q u i s i t i o n s S e m i n a r . c o m

Tax Considerations in Buying/Selling An AgencyThis example illustrates the double taxation of a “C” corporation.  Electing “S” corporation status can  minimize or eliminate the corporate level tax. 

• Caveat:The IRS requires that a corporation that was a “C” and elected “S” must pay a corporate level tax if it sells its assets within 10 year of electing “S” status.  This is referred to as a built in gains tax. It is measured on the difference between the fair market value of the company’s assets on the day the election is effective and their tax bases.

Example – Assume the same facts as the previous example, but that Kane elected “S” status effective1‐1‐2014. Its built in gain is as follows:

Built InAsset FMV Basis Gain

Fixed assets $   300,000 $200,000 $    100,000Goodwill $3,000,000 ‐ $3,000,000

Assume 6 years later Kane, Inc. sells its assets when the goodwill is worth $5,000,000. Kane will pay a corporatetax on $3,000,000 but not on the additional $2,000,000.

To prove the value of the assets a valuation should be obtained as of the effective date of the S Election.  Failure to do so could result in the IRS treating the entire gain as subject to the built in gains tax.

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Tax Considerations in Buying/Selling An Agency• Note – Selling stock in an “S” corporation avoids the built in gain tax.

If assets are sold, Form 8594 must be attached to the buyer and seller’s tax returns. The allocationof the purchase price among the assets purchased is disclosed on this form. The buyer andsellers’ forms should agree, otherwise, it could generate an audit from the IRS.

• Note – If the corporation was always an “S” corporation the built in gain tax does not apply.

Covenants not to compete – typically in the purchase of a business, the buyer will want theseller to execute a covenant not to compete.

Tax treatment of covenant not to compete –

1. Seller – ordinary income (not subject to self‐employment tax)2. Buyer – amortized over 15 years even if term of the covenant is for fewer years (i.e. 2‐3

years)

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Tax Considerations in Buying/Selling An Agency• Installment Sale – If the sale of the business is done over time, the seller recognizes 

gain as payments are made by buyer.  This will spread the gain over a number of years.  (Exception – depreciation recapture, must be reported in the year of sale even if no funds are received. Depreciation recapture is treated as ordinary income).

Installment Sale Tax Treatment –

Seller – Capital gain as payments are received based on gross profit percentage.(Exception – depreciation recapture in year of sale. Therefore, buyer must receiveenough cash to pay tax on ordinary income).

Buyer – Purchase price is allocated in the same manner as an all cash deal.

Note – Interest must be stated in an installment agreement otherwise it will beimputed.

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Tax Considerations in Buying/Selling An Agency• Stock Purchase Treated as An Asset Purchase – Section 338(h)(10) Election

Stock is purchased but the transaction is treated as if assets were purchased. Sellingcorp. is treated as if it sold its assets at fair market value and then liquidated. Thiselection is only available to corporations filing consolidated returns and to “S”corporations.

Tax Effect to “S” Corp – Seller – Possible additional ordinary income due todepreciation recapture.

Tax Effect to Buyer – Same as asset purchase.

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Tax Considerations in Buying/Selling An AgencyTake Aways:

• Seller1. Try to incur one level of tax.  If not already an S Corporation, make an S election 

and get clock running on 10 year built‐in gain period.

2. Sell stock if possible.

3. Minimize amounts subject to ordinary income tax rates such as covenant not tocompete and consulting agreements.

• Buyer – Purchase assets not stock. This will result in depreciation/amortization of thepurchase price.

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