It is a no brainer that the IRS is going to want to learn about the sale of your business’ assets and the details in which you report on IRS Form 8594. The details of this form and what numbers to put in Asset Classes I-VII are often part of the second round of negotiations that your m&a advisor and accountant undertake after an agreement on price is reached. The imposition of Uncle Sam has known to derail a deal or two when parties could not agree on how to allocate the purchase price for tax purposes. The seller’s team will want to maximize its allocation to those asset classes (i.e goodwill) that are taxed at long term capital gains rates whereas the buyer’s side is looking to obtain the greatest deductions with the shortest timeframes.
If an agreement cannot be reached then how about having both parties agree to not agree on how the purchase price will be allocated. There is no requirement that states you must have a tax allocation agreement in place for an asset sale. In this scenario both parties are free to indicate their belief of fair value of the assets in question. Within our niche sector due to the lack of tangible assets, goodwill often makes up a significant portion of the allocation as requested by sellers and often time buyers would like a significant portion dedicated to non compete and consulting agreements. If the gap cannot be filed then it may make sense to not agree. Keep in mind the IRS is not going to sit back quietly while the seller allocates 100% of the deal to goodwill and the buyer 100% to a non compete agreement. You will need to be able to defend your fair value beliefs. Also if there is an agreement on how to allocate the purchase price then both parties must adhere to that agreement when filing taxes.
Asset Classes Defined
For asset acquisitions occurring after March 15, 2001 make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order:
Class I assets:
- Cash and general deposit accounts (including savings and checking accounts).
- Does not include certificates of deposits held in banks, savings and loan associations, or other depository institutions.
Class II assets:
- Certificates of deposit
- U.S. government securities
- Foreign currency
- Publicly traded personal property, including stocks and securities.
Class III assets:
- Accounts receivable
- Other debt instruments
- Assets that you mark to market at least annually for federal income tax purposes.
Class IV assets:
- Property of a kind that would properly be included in inventory if on hand at the end of the tax year or
- Property held by the taxpayer primarily for sale to customers in the ordinary course of business.
Class V assets:
- All other assets other than Class I, II, III, IV, VI, and VII assets.
- Example of assets included in this class:
- Furniture and fixtures, equipment, buildings, land, and vehicles.
Class VI assets:
- Section 197 intangibles (other than goodwill and going concern value).
- Examples include, workforce in place, customer lists, clients lists, patient lists, trademarks, trade names.
- Goodwill is:
- Associated with a company’s good reputation in terms of the products it sells, the services it performs, and it’s standing in the community.
- Tied to the ability of a business to continue doing business with its existing customers and to attract future customers.
- An intangible asset that may only be acquired as part of the acquisition of a business.
- A Section 197 intangible whose value is amortized over 15 years by the purchaser of a business.
- Goodwill generally represents the excess of the price paid for a business over its net asset value (also called book value).
- Goodwill is:
- Going concern value:
- Going-concern value is the value attributed to a business entity as anon-going enterprise.
- Going-concern value focuses mainly on the ability of the company’sassets to generate a return on investment not simply goodwill.
If an asset described in (I) through (VI) is includible in more than one category, include it in the lower number category.