Glen Birnbaum presentation to Illinois State Bar Association in Chicago. Business Sales and Acquisitions: The Basics of Asset and Stock Transactions on April 22, 2015. Peoria CPA firm Heinold Banwart

1. o Asset Sale
o Stock Sale
o Tax Strategies on Disposition
TAX IMPLICATIONS OF ASSET
VS. STOCK SALES
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2. Glen Birnbaum, CPA
Shareholder at Heinold Banwart, Ltd – CPA firm in East
Peoria, Illinois – about 50 employees
Experience:
• Valuation – in particular: working capital targets in the
context of M&A, due diligence, estate and gift tax
valuation discounts
• Audit – in particular: manufacturing and agriculture
• Tax – S corps, partnerships, LLC’s, & 263A inventory
capitalization
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3. 1. Asset Sale
• S corp seller
• C corp seller
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4. Asset Sale: S Corp Seller
• Seller (S corporation) recognizes gain based on tax rate
applicable for that asset
o Cash basis receivables (ordinary income tax rates)
o Equipment depreciation recapture (ordinary income
tax rates) - §1245
o Real estate depreciation recapture (maximum 25%
federal tax rate) - §1250
o Capital gain (15-20% federal tax rate) - §1221
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5. Asset Sale: S Corp Seller (cont’d)
• Sales price allocation matters
o How the price is allocated amongst the assets
• The more proceeds which are allocated to ordinary income
assets, the higher the tax liability
• Seller wants to skew sales price to capital assets which
generate capital gain
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6. Asset Sale: C Corp Seller
• Seller (C corporation) recognizes gain based on C
corporation brackets
o No distinction between capital gain on land vs. equipment
depreciation recapture for example
o No lower capital gains rate inside a C corporation
• Do not put appreciating assets (farmland, marketable
securities, etc.) in a C corporation
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7. Asset Sale: C Corp Seller
• Double tax for an asset sale
o First, when the assets are sold
o Then, when cash is distributed to owners
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8. C Corp Double Tax Example
Asset proceeds = $1,125,000
Tax basis in assets = $125,000
Gain on sale = $1,000,000
Corporate tax = $340,000
Liquidating distribution = $785,000
Capital gain on liquidation = $157,000 (double tax)
Net aftertax proceeds = $628,000
Total taxes paid = $497,000
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9. Asset Sale: C Corp Tax Brackets
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10. Reporting An Asset Sale
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11. Reporting An Asset Sale
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12. Asset Sale: Buyer
• Buyer gets to start fresh and depreciate assets at what was
paid for them (fair market value) - §1012
• Buyer prefers ordinary income assets because, generally,
depreciable life is shorter
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13. Asset Sale: Buyer
Example Write-off Periods
o Inventory: 1 year (assume sold in the first year)
o Equipment: 5-7 years
o Goodwill: 15 years - §197
o Building: 39 years
o Land: No depreciation allowed
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14. Asset Sale Allocation: Tug of War
Between Buyer and Seller
• What is good for one is likely bad for the other
• Negotiation!
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15. Allocation of Sales Price
• Both Buyer and Seller must report allocations
made pursuant to §1060 on Form 8594
• Residual allocation method described under
Regs. §1.1060-1(e)
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16. Reporting : Form 8594
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17. Asset Sale: Form 8594
• Class 1 – checking & saving cash
• Class 2 – CDs, publicly traded stock
• Class 3 – trade receivables
• Class 4 - inventory
• Class 5 – property, plant and equipment
• Class 6 – customer lists, trade names, etc.
• Class 7 – goodwill
Regs. §1.338-6(b)(1),(2)(i)-(vii)
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18. 2. Stock Sale
Assumption: An individual is selling the stock
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19. Stock Sale
• Seller recognizes capital gain on sale of stock
o Capital gains usually taxed at a lower rate
• Proceeds - tax basis in the stock = gain
• §1221 defines a capital asset
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20. Stock Sale - Basis
• Basis in Stock – C corporation
• Original investment “paid in capital” of company (usually
very low)
• Amount paid for the stock
• Basis in Stock – S corporation - §1367
o Original investment + share of income and losses
- distributions
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21. Stock Sale – Basis: C vs S
Basis does not increase when C corp retains profits
Basis does increase when S corp retains profits
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22. Stock Sale - Basis
KEY POINT:
• This basis increase for an S corporation
shareholder is what avoids the “double tax” later
when S corp assets are sold and cash distributed
out.
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23. Stock Sale - Gain
• Gain on Sale– C corporation
• Subject to net investment income tax - §1411
– 3.8% surtax, generally for individuals with Adjusted
Gross Income (AGI) over $250,000
• Gain on Sale– S corporation
o Not subject to net investment income tax generally if the
owner was a material participant in the business -
§1411(c)(4)
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24. Stock Sale – §1202
• A partial exclusion may be available for Qualified Small
Business Stock – essentially C corp stock held more than 5
years
• 50% exclusion for stock acquired after 8/10/1993
• 75% exclusion for stock acquired after 2/17/2009 and before
2/28/2010
• 100% exclusion for stock acquired after 2/27/2010 and
before 1/1/2015
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25. Stock Purchase
• Buyer takes cost basis in the stock - §1012
• Stock is a nondepreciable asset, however
• Target corporation retains various attributes including net
operating loss carryforwards, credit carryforwards,
accounting methods, etc.
• Attributes may be limited however - §382/383/384
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26. Stock Purchase
• Buyer generally does not prefer stock sale, because old tax
basis in assets of corporation carries over
o Basis not stepped up to true asset value
o Carryover depreciation
• Impact: Buyer will typically demand a discount if buying
stock
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27. §338(h)(10) Election
• A bilateral election under §338(h)(10) permits a step up in
the assets for a buyer while purchasing the stock of a target
corporation
• Legally the deal is a stock transaction, but treated as a
deemed sale of assets for tax purposes
• Generally desirable for a target S corporation with high value
and low basis such as goodwill or other intangibles
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28. Stock Purchase: Buyer Caution
• Buyer buys stock and pays $400,000 more than “inside
basis” of the assets of the S corporation
• Pays the Seller $400,000 “extra” for goodwill (internally
generated)
• This $400,000 difference is not depreciable by the Buyer
because it is a purchase of stock.
• $400,000 in “lost” amortization for the Buyer
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29. Stock Purchase Caution
Several years later S corporation sells all assets in a taxable
transaction and the corporation liquidates in the same year.
• What if goodwill was sold for:
A. $500,000?
B. $300,000?
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30. A - $500,000
$500,000 long term capital gain at entity level
-
$400,000 long term capital loss at individual level
=
$100,000 net long term capital gain
Federal taxes paid of $20,000 (20% of $100,000)
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31. B - $300,000
$300,000 long term capital gain at entity level
-
$400,000 long term capital loss at individual level
=
$100,000 net long term capital loss (only deductible at
$3,000 per year)
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32. Stock Purchase Caution
Lesson #1
• Paying $400,000 more than inside tax basis means a
guaranteed $400,000 loss on liquidation
• Try to ensure there is at least $400,000 capital gain
generated at the entity level if selling assets (negotiate
favorable allocation)
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33. Stock Purchase Caution
• What if the corporation is not liquidated until the year after
sale?
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34. Stock Purchase Caution
$500,000 long term capital gain at entity level taxed in year 1
$400,000 long term capital loss at individual level recognized
in year 2
Taxes paid year 1 = $100,000 ($500,000 x 20%)
$80,000 more taxes paid than A example previous!
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35. Stock Purchase Caution
Lesson #2
• Make sure you time the liquidation of the corporation in the
same year as the gain on sale of assets.
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36. Reporting a Stock Sale
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37. Asset vs. Stock: Tax Comparison
• Buyer prefers asset sale because it gets to depreciate the
purchase price
o Higher tax depreciation = Taxes saved = More cash
o Able to put more cash toward paying down the purchase
debt incurred
o Particularly helpful in the early years when cashflow may
be tight already
• Seller prefers stock sale because taxes are generally lower
(lower capital gains rates)
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38. Tax Strategies On Disposition
• Non-compete Agreements
• Personal Goodwill
• Consulting Agreements
• Installment Sales
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39. Non-Compete Agreements
• Seller (shareholder) receives ordinary income as payments
are received - income not subject to self-employment taxes
• Buyer deducts over 15 years under §197
• Avoids second layer of tax by paying directly to owner and
not the C corporation (asset sale)
• Seller needs to be able to compete. The younger the seller,
the more value that can be allocated to the agreement
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40. Personal Goodwill
• Seller (shareholder) receives capital gain income as
payments are received
• Buyer deducts over 15 years under §197
• Avoids second layer of tax by paying directly to owner
and not the C corporation (asset sale)
• Facts and circumstances (Martin Ice Cream case)
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41. Consulting Payments
• Seller (shareholder) recognizes ordinary income as
payments are received, self employment tax generally
applies
• Buyer deducts as paid – not over 15 years
• Avoids second layer of tax by paying directly to owner
and not the C corporation (asset value)
• Beware of family attribution rules on C corporation
redemptions
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42. Installment Sales
• Seller does not receive proceeds all in one year,
and instead, takes “Seller Paper”
o Finances part of the purchase price for the buyer
• Can be combined with some sort of earnout where
if Company customers are kept, seller gets more
money
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43. Installment Sales
• Ability to spread out income prorata as payments are
received by the Seller (lower tax rates) - §453
• Primary Exceptions:
o Depreciation recapture on equipment
• Gain all triggered in year 1, even if being paid over
5 years, for example
o Cash basis receivables
• Be careful of related party rules—may not be able to defer
gain on related party sales
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44. Takeaways
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• There is no (lower) capital gain rate inside a C corporation
• There is a double tax if assets are sold inside a C corporation
and cash is later distributed to stockholders
• Be careful when buying stock and paying more than “inside
tax basis”
• Carefully consider when corporation liquidation should occur
after a sale of corporate assets
• Several strategies exist to plan for the “double tax”

45. Questions?
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46. Thank You!
Glen Birnbaum, CPA
gbirnbaum@hbcpas.com
201 Clock Tower Drive, Third Floor
East Peoria, IL 61611
www.hbcpas.com309·694·4251
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