The sale of a business involves the selling of separate assets. These assets are the property held by the company that is primarily used for investments and for the usual useful business operations, which then resulted in business profits. The Internal Revenue Code treats these assets differently, the law requires that gain or loss be determined for each separate asset in the sale of the business.
The amount of tax that will be paid depends upon whether the money you make from the sale is taxed as ordinary income or capital gains. Profit received from the sale of the business assets will most likely be taxed at capital gains rates, whereas the amount you receive under a consulting agreement will be ordinary income.
Capital gains are a different type of income from ordinary income on business profits. Taxes on capital gains taxes come into play when a capital asset is sold. Capital assets are typically part of the sale of a business. Property held short-term and receivables and inventory are subject to ordinary gain or loss. Assets held by the company for more than 1 year are generally treated as assets, where the recaptured depreciation is taxed as ordinary income and any amounts over that may be taxed at the long-term capital gains rate. The definition of assets does not confine in properties, it also includes any goodwill or going concern value, or any intangible properties of the business. Under the law, long-term capital gains of individuals are taxed at a significantly lower rate than ordinary income. If held the assets longer than 12 months, the maximum tax on long-term capital gains is 17% for qualifying taxpayers.
A corporation is owned by the shareholders. Their interest in the corporation is represented by stock certificates, and selling it would a capital gain or loss is realized. However, when a corporation is sold, the shares of the corporation are valued and the difference in value is considered a capital gain or loss, reportable on the shareholder's personal tax return.
An interest in a partnership or joint venture is treated as a capital asset when sold. The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary gain or loss. The partnership share of a partner is considered a capital asset and results in a capital gain (or loss) when sold. The shares of a shareholder are capital gains or losses when sold, either as part of a business sale or when a shareholder wishes to be cashed out.
The amount of revenue that the business will earn will depend on the business and how well it is managed, future taxes may be affected by how the purchase price of the business is allocated among the assets. The tax code enumerates the seven (7) classes of assets where the market value can easily be determined, such as cash or securities, to tangible property, such as tools and machinery; intangible property, such as patents and trademarks, where the fair market value of the assets are more difficult to determine; and goodwill, which can only be quantified by subtracting all the other assets from the purchase price. The cost of intangible assets and goodwill must be amortized over a 15-year period, whereas most other property, except for real estate, can be depreciated more quickly. Hence, if the greater the proportion of the purchase price is assigned to quickly depreciated assets, the greater the value of the future cash flows of the business after taxes, and the more valuable the business.
The buyer and seller most of the time negotiate to the total price of the business and agree as to what portion of the purchase price applies to each individual asset, as well as to intangible assets. However, the buyer would tilt his favor to choose several types of depreciation for most types of tangible property, thus giving the choice to depreciate most of the value quickly, or incrementally over the class life. The buyer would tend to allocate part of the purchase price to tangible property for depreciation is faster than amortizing the same costs over a 15-year period. As to the seller, the allocation of the purchase price would be greater to intangible property, it is treated as a capital gain, which is usually lower than the ordinary tax rate for high-income taxpayers.
In apportioning some of the price from real estate to intangibles, benefits both buyer and seller. Real estate can only be depreciated over a much longer time, up to 39 years for commercial property. Again, there are limits to this allocation, but there is wiggle room because most property cannot be priced precisely — only estimated.
The purchase price allocation of assets by the seller and buyer is not absolute, for the Internal Revenue Code provides for some restrictions. Lastly, agreement during the negotiation stage is necessary to avoid IRS scrutiny for it may invite IRS audit.
J.R.'S TAX SERVICE