Most sales of small and mid-sized businesses involve the transfer of specific business assets, such as trade name, equipment, and inventory, rather than stock in the corporation that might own the assets. Allocating the price is a process whereby the parties stipulate what portion is applied to what part of the business assets. Some assets are taxed differently than others. For example, depending on the state, the transfer of furniture, fixtures, and equipment could be a “bulk sale” and subject to sales tax. And, different types of assets are depreciated over different periods of time, with the buyer and seller facing different tax consequences. Both parties are required to agree to the same allocation or face the prospect that the IRS will determine the allocation - probably to their mutual disadvantage. This is both a technical accounting procedure and a tactical negotiating factor best handled by experts – your CPA and attorney – and coordinated by your escrow agent.
Allocation or Purchase Price Allocation is often done during the escrow process here in CA. It's goal is to bring the buyer and seller together on the values in the transaction to meet IRS tax requirements or the completion of IRS Form 8594.
Allocating the purchase price has killed many deals as the seller wants to maximize their tax position and so does the buyer. If they can't agree the deal may fall apart. Discuss the allocation or Purchase Price Allocation early in your transaction as it may be a deal killer as I have seen happen before.
Allocation, is a term used in business transfers, as the assets being transferred must be divided into categories (Tangible & Intangible). This is termed the Allocation of Purchase Price. The Inventory, Fixtures and Equipment, Good Will, Covenant not to Compete, Leasehold Value, Equipment and numerous other varying categories that may be used in definition of the asset being transferred. It is advised that you consult your Accountant before deciding this issue. The taxes paid by the Seller on the transfer are partially determined by the allocation of the original purchase price as well as the sale in process. The Buyers taxes will also be determined as there are different tax consequences to separate categories. The time of depreciation does vary from one category to the other.
When a business is sold, the purchase price of the business is typically apportioned, or "allocated" over several items. These can include different business assets as well as one or more separate contractual agreements, such as a consulting agreement for the Seller to stay on for a period of time, or a non-compete agreement requiring the Seller to not open a competitive business for a period of time.
Allocations are often negotiated as part of a transaction, and the way proceeds of the sale are allocated can have significant tax implications for both the Buyer and Seller. For example, a Buyers may want to allocate as much of the purchase price as possible to items that they can deduct on future business tax returns quickly, rather than having to amortize deductions over a long period of time. A Seller, depending on their tax position, may have different needs.
The tax impact of allocations depends on the needs and current tax position of the Buyer and Seller specifically, and it is important to consult with a tax professional to determine the impact before entering into a purchase agreement.
The allocation of the sale price of a business has serious consequences for both the buyer and seller, very often the source of a deal falling apart. Allocating the price is a process whereby the parties stipulate what portion is applied to what part of the business assets. Some assets are taxed differently than others. For example, depending on the state, the transfer of furniture, fixtures, and equipment could be subject to sales tax. And, different types of assets are depreciated over different periods of time, with the buyer and seller facing different tax consequences. This is both a technical accounting procedure and a tactical negotiating factor best handled by experts - your CPA and attorney.
Most sales of small and mid-sized businesses involve transfer of specific business assets, such as trade name, equipment and inventory, rather than stock in the corporation that might own the assets. Because there are tax consequences attached to ownership of each asset, the business buyer and seller need to allocate a portion of the price to each of the assets, with the total value of those assets equaling the business sale price. They use IRS Form 8594 to submit the allocation to the IRS and even though each party might have a different way of allocating the price, seeking to maximize his or her tax advantages, both are required to agree to the same allocation, or face the prospect that the IRS will determine the allocation - probably to the disadvantage of both parties.
Among the assets sold in a business transfer and assigned a value in the allocation are tangible items, having a physical form, such as tools and equipment, leasehold improvements (unless they belong to a property owner who rents the premises to the business), furniture, fixtures, and inventory. Also to be assigned values are the intangible assets such as the trade name, goodwill, leasehold interest and patents, permits and licenses.
Because tangible assets generally can be depreciated, which is a strategy for reducing taxable income by their new owner, the buyer usually wants to allocate much of the price for this category of assets. But with a high value placed on tangible assets in a deal, comes the likelihood that the seller will have to pay capital gains taxes. The tangibles may have been fully depreciated on the seller's business books, but have the substantial dollar values assigned in the allocation. Another asset the buyer likes to purchase at a high value is the seller's covenant not to compete, and it will be amortized over the length of the covenant. For the seller, however, payment on a covenant is treated as regular income, subject to a higher tax rate.
Conversely, the seller may want a higher dollar amount placed on an intangible asset, such as good will, if it is associated with a substantial book value and will expose the seller to little tax liability. But this is not a popular asset for a buyer who, according to the rules, will have to wait 15 years to fully depreciate this intangible.
