Most business sellers operating their business through a C corporation do not look beyond the closing. A reoccurring tax issue for many business sellers arises when the shareholder(s) elects to sell his business, and at closing, then realizes that his net "after tax" dollars is much less than expected because of the dreaded "double tax". This occurs because most buyers refuse to purchase the stock of the corporation (since they do not want to assume any existing liabilities and they want to obtain a "stepped up" basis in the assets purchased) and instead prefer an "asset" purchase. As a result, the sale proceeds are taxed at the corporate level and then again upon a distribution to the shareholder. Although a portion of the consideration paid to the seller can often be allocated toward the Management Assistance, Training and Consulting and Covenant Not To Compete payments following the closing, these amounts shall be subjected to ordinary income tax rates and employment taxes.
With some creative tax planning, it is possible to eliminate this "double taxation" and receive long-term capital gain treatment. The most effective way to resolve this dilemma may be to allocate a substantial portion of the consideration paid by the buyer toward "Personal Goodwill." By bifurcating the goodwill of a business into two components, goodwill created by the corporation and goodwill created by the individual shareholder(s), it may be possible to treat the shareholder\''s personal goodwill as a separately salable asset which avoids double tax and is subject to the much lower capital gains rates (15 percent rather than 35 percent). This position is particularly supportable in the instance where the success of the business is largely dependent upon the personal reputation and contacts of the shareholder-seller.
Although the allocation of the sales price among the various tangible and intangible assets is negotiated between the buyer and seller, and part of the consideration paid will have to be allocated to the corporate assets, the amount so allocated is much less and a deductible bonus or other payment may effectively eliminate the double tax.
This newsletter was published to raise awareness of the issues surrounding the sale of a privately held business. It is not legal or tax advice and should not be soley relied upon when engaging in the sale of a business. Instead, you should seek the advice of a professional business broker, attorney or tax advisor.
