The sale or purchase of a business involves The sale or purchase of a business involves many decisions which create tax impacts for the parties involved, both at the time of closing and in the future. While the media reports focus on multi-billion-dollar mergers and acquisitions, most business transfers involve far less in the amount of money involved, but each sale or purchase represents a large investment of money, time, and emotion in the business by both the seller and buyer. In every transaction, the taxing authorities, either as a result of the completion of the sale of a business, or in the future as the business continues to operate, will receive taxes from the seller or buyer.
Businesses can be sold in a number of ways, including the sale of stock or limited liability company membership interests, however most purchasers do not want to assume the potential risk of past tax or operating liabilities of the business entity, or the purchaser does not want to inherit the tax basis of the business entity in the various assets which have been partially or fully depreciated. Accordingly, for the bulk of business transfers, the seller and purchaser will structure the business sale as an asset sale and purchase.
An asset sale and purchase presents a number of tax implications, most of which are largely dependent on how the seller and buyer agree to allocate the purchase price. As required by IRC Section 1060, the parties must agree in writing on the allocation of the price, and they report such allocations on IRS Form 8594. Some of the typical allocation categories will include equipment, vehicles, inventory, non-competition agreements, intangible assets (e.g. licenses), and goodwill or blue sky of the business. The impact on the seller will be to establish capital gain tax to be paid, or ordinary income tax on certain of the assets within the allocated categories. The impact on the purchaser will be to set the new depreciable tax basis in tangible assets and amortizable values of intangible assets.
The often overlooked tax in an asset sale transaction are the Colorado and city sales tax assessed on tangible property, e.g. equipment and motor vehicles. Many sellers and purchasers assume that because sales tax was paid at the time a business originally purchased equipment or motor vehicles for use in the business, that no sales tax is owing when those assets are later sold to a purchaser of the business. Colo. Rev. Stat. Section 39-26-104 broadly imposes sales tax on the sale of tangible personal property. Certain exemptions from sales tax do exist, such as the exemption for equipment used in manufacturing being available in the right type of business, however without the presence of an exemption, the parties should plan for the payment of sales tax at the time of closing on the business sale and purchase. Allocating a large portion of the purchase price to equipment can be advantageous to the purchaser from an income tax perspective by increasing the tax basis of the equipment to allow for greater depreciation or IRC Section 179 deduction, however the higher equipment value allocation creates an immediate need for additional cash to be available to pay a higher sales tax amount, so consideration of the cost-benefit of the amount allocated to equipment is important. Sales tax will be owed to the State of Colorado for the state and county sales tax owing, and if the business is subject to city-imposed sales tax, such as the City of Longmont, the applicable sales tax amount will be owing to the city.
Communication and coordination between the team of the client, whether a purchaser or seller, their attorney, CPA, and if applicable, their business broker, at the early stages of negotiating a business sale or purchase, is critical to allow the parties to discuss and understand the tax implications of the values to be allocated between the various assets, and to plan and provide funding for the payment of applicable sales tax.