Published By The Center for Financial , Legal & Tax Planning, Inc.
Roman A. Basi, President of The Center, is an Attorney, CPA, Real Estate Broker, and Title Insurance Agent. Roman speaks and advises The Center’s clientele on such matters as Business Law, Succession, Estate & Tax Planning and Real Estate.
Dr. Bart A. Basi, Senior Advisor of the Center for Financial, Legal & Tax Planning, Inc., is an expert on closely-held companies, an attorney, and CPA. He is a member of the American Bar Association’s Tax Committees on Closely-Held Businesses and Business Planning.
Are you familiar with basis? It’s vital to understand the role basis plays, whether asset basis or stock basis in the purchase price allocation and overall structure when buying or selling a business. Buyers generally favor an asset sale for the stepped-up asset basis. Stepped-up asset basis is an upward readjustment of value in a fixed asset for tax purposes upon inheritance of such asset. This upward readjustment in basis allows the buyer larger asset depreciation and amortization, which in turn lowers the business’s taxable income. A seller however will seek to allocate a lower adjusted book value to its assets in an attempt to allocate the rest to company or personal goodwill. Under the seller’s preferred allocation, the buyer loses some of its stepped-up basis thus lowering their amount of depreciation and amortization.
To make matters more complex, a stock sale measures stock basis in a manner far different than asset basis in an asset sale. Based on the entity election, an S-corporation (S-Corp) or C-corporation (C-Corp), stock basis is measured differently and it’s vital for a seller to understand their business’s stock basis in order to minimize their taxes when selling. This article will offer guidance regarding the interplay of basis between an asset purchase and stock purchase while providing insight on how to strategically structure the purchase price allocation to benefit your interests. Asset Basis Asset basis, and more specifically adjusted asset basis plays a vital role in the taxation aspect of a merger or acquisition. An asset adjusted basis (or book value) is calculated using the asset’s original cost then making adjustments upward based on investment into improving the asset, or more commonly downward through depreciation, amortization, and Section 179 deductions.
For example, you purchase a machine for $50,000 and under the Tax Cuts and Jobs Act you use bonus depreciation on the asset to reduce your business’s taxable income. However, an interested Buyer approaches seeking to buy all the assets of your business (essentially acquiring your company). In purchasing the assets of your business, a price will be allocated to your assets. If the asset price allocation exceeds the adjusted basis of your assets you’ll be subject to a Seller’s worst nightmare in the form of depreciation recapture. Depreciation recapture is the gain received from the sale of depreciable property that must be reported as income. The gain reported as income will then be subject to a higher income tax rather than what would otherwise be capital gains. As the example above provides the importance in understanding not just asset basis, but adjusted asset basis as that will be the purchase price target from a seller’s standpoint. To add more complexity, the IRS requires assets in an asset sale be sold at fair market value. How do you coincide fair market value and adjusted asset basis when it comes time to allocate the purchase price? The answer is obtaining representation who can command a presence, understand the nature of the allocation, and control the negotiations with the buyer. If not, a seller risks vulnerability to income tax through depreciation recapture that will quickly reduce your net selling price.
Stock Basis It’s important for a seller to be aware of the different stock basis calculations regarding an Scorporation and C-corporation. S-Corp basis calculations are more complex than C-Corp basis calculations. A CCorp’s stock basis stays the same year to year while an SCorp’s basis is an annual moving target based on annual income, distributions, and loans. It’s vital to calculate and understand an S-Corp’s stock basis as the basis determined will be the cash shareholders can pull out of the company without realizing income or gain. From a selling standpoint, basis is the cash shareholders can obtain “without realizing income or gain”, which equates to the tax-free amount when the company is sold. An S-Corp’s stock basis will decrease when distributions are made to shareholders, or deductions or losses take place.
However, the stock basis will increase when capital contributions are made, ordinary income increases, or investment income and gains are made. The value in having high basis when selling your business is paramount to minimizing tax liabilities. Conclusion A major aspect of buyer/seller negotiations revolve around the purchase price allocation of the transaction. A purchase price allocation that is heavily determined by the amount of basis within a business. At The Center for Financial, Legal & Tax Planning, Inc., we’re able to break down your business’s basis, strategically allocate your transaction, and perform a Tax Minimization Analysis that provides a business’s tax liability down to the individual shareholder level. If you’re interested in buying or selling a business, or you’re in the process of buying or selling a business, contact The Center for Financial, Legal & Tax Planning, Inc., at (618)-997-3436.
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