Post on 16-Aug-2015
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o Asset Sale
o Stock Sale
o Tax Strategies on Disposition
TAX IMPLICATIONS OF ASSET VS. STOCK SALES
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Glen Birnbaum, CPAShareholder at Heinold Banwart, Ltd – CPA firm in East Peoria, Illinois – about 50 employees
Experience:• Valuation – in particular: working capital targets in the
context of M&A, due diligence, estate and gift tax valuation discounts
• Audit – in particular: manufacturing and agriculture• Tax – S corps, partnerships, LLC’s, & 263A inventory
capitalization
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1. Asset Sale
• S corp seller
• C corp seller
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Asset Sale: S Corp Seller• Seller (S corporation) recognizes gain based on tax rate
applicable for that asseto Cash basis receivables (ordinary income tax rates)o Equipment depreciation recapture (ordinary income
tax rates) - §1245o Real estate depreciation recapture (maximum 25%
federal tax rate) - §1250o Capital gain (15-20% federal tax rate) - §1221
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Asset Sale: S Corp Seller (cont’d)
• Sales price allocation matterso How the price is allocated amongst the assets
• The more proceeds which are allocated to ordinary income assets, the higher the tax liability
• Seller wants to skew sales price to capital assets which generate capital gain
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Asset Sale: C Corp Seller
• Seller (C corporation) recognizes gain based on C corporation bracketso No distinction between capital gain on land vs. equipment
depreciation recapture for exampleo No lower capital gains rate inside a C corporation
• Do not put appreciating assets (farmland, marketable securities, etc.) in a C corporation
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Asset Sale: C Corp Seller
• Double tax for an asset saleo First, when the assets are soldo Then, when cash is distributed to owners
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C Corp Double Tax Example
Asset proceeds = $1,125,000Tax basis in assets = $125,000Gain on sale = $1,000,000Corporate tax = $340,000
Liquidating distribution = $785,000 Capital gain on liquidation = $157,000 (double tax)
Net aftertax proceeds = $628,000Total taxes paid = $497,000
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Asset Sale: C Corp Tax Brackets
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Reporting An Asset Sale
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Reporting An Asset Sale
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Asset Sale: Buyer
• Buyer gets to start fresh and depreciate assets at what was paid for them (fair market value) - §1012
• Buyer prefers ordinary income assets because, generally, depreciable life is shorter
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Asset Sale: Buyer
Example Write-off Periods
o Inventory: 1 year (assume sold in the first year)o Equipment: 5-7 years o Goodwill: 15 years - §197o Building: 39 yearso Land: No depreciation allowed
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Asset Sale Allocation: Tug of War Between Buyer and Seller
• What is good for one is likely bad for the other
• Negotiation!
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Allocation of Sales Price• Both Buyer and Seller must report allocations
made pursuant to §1060 on Form 8594
• Residual allocation method described under Regs. §1.1060-1(e)
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Reporting : Form 8594
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Asset Sale: Form 8594
• Class 1 – checking & saving cash• Class 2 – CDs, publicly traded stock• Class 3 – trade receivables• Class 4 - inventory• Class 5 – property, plant and equipment• Class 6 – customer lists, trade names, etc.• Class 7 – goodwill
Regs. §1.338-6(b)(1),(2)(i)-(vii)
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2. Stock Sale
Assumption: An individual is selling the stock
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Stock Sale
• Seller recognizes capital gain on sale of stocko Capital gains usually taxed at a lower rate
• Proceeds - tax basis in the stock = gain
• §1221 defines a capital asset
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Stock Sale - Basis
• Basis in Stock – C corporation• Original investment “paid in capital” of company (usually
very low) • Amount paid for the stock
• Basis in Stock – S corporation - §1367o Original investment + share of income and losses
- distributions
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Stock Sale – Basis: C vs S
Basis does not increase when C corp retains profits
Basis does increase when S corp retains profits
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Stock Sale - Basis
KEY POINT:
• This basis increase for an S corporation shareholder is what avoids the “double tax” later when S corp assets are sold and cash distributed out.
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Stock Sale - Gain
• Gain on Sale– C corporation• Subject to net investment income tax - §1411
– 3.8% surtax, generally for individuals with Adjusted Gross Income (AGI) over $250,000
• Gain on Sale– S corporationo Not subject to net investment income tax generally if the
owner was a material participant in the business - §1411(c)(4)
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Stock Sale – §1202
• A partial exclusion may be available for Qualified Small Business Stock – essentially C corp stock held more than 5 years
• 50% exclusion for stock acquired after 8/10/1993
• 75% exclusion for stock acquired after 2/17/2009 and before 2/28/2010
• 100% exclusion for stock acquired after 2/27/2010 and before 1/1/2015
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Stock Purchase
• Buyer takes cost basis in the stock - §1012• Stock is a nondepreciable asset, however
• Target corporation retains various attributes including net operating loss carryforwards, credit carryforwards, accounting methods, etc.• Attributes may be limited however - §382/383/384
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Stock Purchase
• Buyer generally does not prefer stock sale, because old tax basis in assets of corporation carries overo Basis not stepped up to true asset valueo Carryover depreciation
• Impact: Buyer will typically demand a discount if buying stock
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§338(h)(10) Election
• A bilateral election under §338(h)(10) permits a step up in the assets for a buyer while purchasing the stock of a target corporation
• Legally the deal is a stock transaction, but treated as a deemed sale of assets for tax purposes
• Generally desirable for a target S corporation with high value and low basis such as goodwill or other intangibles
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Stock Purchase: Buyer Caution
• Buyer buys stock and pays $400,000 more than “inside basis” of the assets of the S corporation
• Pays the Seller $400,000 “extra” for goodwill (internally generated)
• This $400,000 difference is not depreciable by the Buyer because it is a purchase of stock.
• $400,000 in “lost” amortization for the Buyer
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Stock Purchase Caution
Several years later S corporation sells all assets in a taxable transaction and the corporation liquidates in the same year.
• What if goodwill was sold for:A. $500,000?B. $300,000?
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A - $500,000
$500,000 long term capital gain at entity level -
$400,000 long term capital loss at individual level=
$100,000 net long term capital gain
Federal taxes paid of $20,000 (20% of $100,000)
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B - $300,000
$300,000 long term capital gain at entity level -
$400,000 long term capital loss at individual level=
$100,000 net long term capital loss (only deductible at $3,000 per year)
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Stock Purchase Caution
Lesson #1
• Paying $400,000 more than inside tax basis means a guaranteed $400,000 loss on liquidation
• Try to ensure there is at least $400,000 capital gain generated at the entity level if selling assets (negotiate favorable allocation)
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Stock Purchase Caution
• What if the corporation is not liquidated until the year after sale?
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Stock Purchase Caution
$500,000 long term capital gain at entity level taxed in year 1
$400,000 long term capital loss at individual level recognized in year 2
Taxes paid year 1 = $100,000 ($500,000 x 20%)
$80,000 more taxes paid than A example previous!
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Stock Purchase Caution
Lesson #2
• Make sure you time the liquidation of the corporation in the same year as the gain on sale of assets.
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Reporting a Stock Sale
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Asset vs. Stock: Tax Comparison
• Buyer prefers asset sale because it gets to depreciate the purchase priceo Higher tax depreciation = Taxes saved = More cash o Able to put more cash toward paying down the purchase
debt incurredo Particularly helpful in the early years when cashflow may
be tight already
• Seller prefers stock sale because taxes are generally lower (lower capital gains rates)
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Tax Strategies On Disposition
• Non-compete Agreements
• Personal Goodwill
• Consulting Agreements
• Installment Sales
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Non-Compete Agreements
• Seller (shareholder) receives ordinary income as payments are received - income not subject to self-employment taxes
• Buyer deducts over 15 years under §197
• Avoids second layer of tax by paying directly to owner and not the C corporation (asset sale)
• Seller needs to be able to compete. The younger the seller, the more value that can be allocated to the agreement
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Personal Goodwill
• Seller (shareholder) receives capital gain income as payments are received
• Buyer deducts over 15 years under §197
• Avoids second layer of tax by paying directly to owner and not the C corporation (asset sale)
• Facts and circumstances (Martin Ice Cream case)
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Consulting Payments
• Seller (shareholder) recognizes ordinary income as payments are received, self employment tax generally applies
• Buyer deducts as paid – not over 15 years
• Avoids second layer of tax by paying directly to owner and not the C corporation (asset value)
• Beware of family attribution rules on C corporation redemptions
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Installment Sales
• Seller does not receive proceeds all in one year, and instead, takes “Seller Paper”o Finances part of the purchase price for the buyer
• Can be combined with some sort of earnout where if Company customers are kept, seller gets more money
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Installment Sales
• Ability to spread out income prorata as payments are received by the Seller (lower tax rates) - §453
• Primary Exceptions:o Depreciation recapture on equipment
• Gain all triggered in year 1, even if being paid over 5 years, for example
o Cash basis receivables
• Be careful of related party rules—may not be able to defer gain on related party sales
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Takeaways
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• There is no (lower) capital gain rate inside a C corporation• There is a double tax if assets are sold inside a C corporation
and cash is later distributed to stockholders • Be careful when buying stock and paying more than “inside
tax basis”• Carefully consider when corporation liquidation should occur
after a sale of corporate assets• Several strategies exist to plan for the “double tax”
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Questions?
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Thank You!
Glen Birnbaum, CPAgbirnbaum@hbcpas.com
201 Clock Tower Drive, Third FloorEast Peoria, IL 61611
www.hbcpas.com309·694·4251