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.