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Allocating the Purchase Price

2 March 2022

In our last installment, we discussed IRS Code Section 1202, pertaining to the tax benefits on sales of qualified small business stocks. Today, we discuss one of the most important facets of the sale of your business – the allocation of the purchase price, once that price has been agreed upon.

When a business is sold, both buyer and seller must file Form 8594, Asset Acquisition Statement, with their individual income tax returns for that year. This form requires a separate listing for each class of asset sold (e.g., stock, in a sale of stock; goodwill; other intangible property; and, in an asset sale, equipment, inventory, land, buildings, etc.). The amounts reported for each class of asset on the buyer’s and seller’s Forms 8594 must agree with the allocation as listed in the Purchase Agreement or other written document, signed by both parties, and with each other’s Form 8594.

The allocation of the purchase price can have a significant impact on the tax liabilities incurred by buyers and sellers pursuant to the sale/acquisition of the business. Mistakes, therefore, can be costly.

Stock Sales:

Allocation of the purchase price in a stock sale is relatively simple by comparison to an asset sale. The principal items to allocate will be:

  • The portion of the purchase price allocatable to the stock itself;
  • Intangible assets;
  • Goodwill;
  • The value of any non-compete or consulting agreement with the seller.

Even agreeing on the value of a business’ goodwill can become a thorny issue, however. Let your Transaction Advisory Team hash out the details with the buyer’s team. They are your experts; trust them to exercise their skill and zeal on your behalf.

Asset Sales:

Allocating the purchase price in an asset sale is more complicated. There are seven classes of assets which must be reported, and arranging the allocation so as to be acceptable to both seller and buyer is a painstaking and time-consuming process.

The seven asset classes are:

  • Cash and cash-like assets;
  • Securities;
  • Accounts Receivable;
  • Inventory;
  • Other Tangible Property: this asset class must be broken out into 1) personal property and 2) real estate;
  • Covenants Not to Compete & Other Intangible Property: this asset class must be broken out into 1) non-compete covenants, and 2) other intangible property not listed in the final asset class below;
  • Goodwill & Going Concern Value

Again, I cannot recommend too highly that your team and your buyer’s team do most of the negotiations between them. Of course, you and your buyer must approve any allocation before the deal can be finalized.

If you are considering a potential sale of your business, I recommend strongly that you consult with us before making any final decisions.

Please click here to let me know how I can help you.

Until next time –

Peace,

Eric

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