For the sale of a company, the allocation of purchase price for tax purposes creates important considerations for both buyers and sellers. The majority of small company sales transactions are structured as asset acquisitions, and the purchase price allocation affects the seller’s tax liability and the buyer’s tax basis in the acquired assets.
- What is a purchase price allocation? The purchase price allocation is the process of assigning the purchase price of a business to the assets sold for purposes of determining taxes owed by the seller, tax basis for the buyer, and reporting requirements to the IRS.
- Who is responsible for purchase price allocation? Both buyers and sellers should submit a purchase price allocation for the tax year of the sale. If the parties submit contradicting purchase price allocations, the IRS may challenge one or both of them; therefore, it is best practice for the parties to agree on an allocation prior to closing.
- Why does is matter? Allocation to the various asset classes can have a major impact on the ultimate value received by the parties to an acquisition. Sellers and buyers purchase price allocation preferences are typically at odds with each other. Sellers usually prefer to allocate as much as possible to capital gain assets and intangibles rather than ordinary income assets, whereas buyers typically want to allocate to assets they can depreciate rapidly. Therefore, the allocation is often a negotiated component of a sales agreement.
- How to Allocate Purchase Price in an Asset Sale? Purchase price is allocated per Internal Revenue Code Section 1060 and filed on IRS Form 8594. The final purchase price should be allocated by starting with the actual value of tangible assets, with the balance allocated to intangible assets. For example, the tangible assets of a services business being sold – such as a law practice – are usually equipment, furniture, supplies, etc. The intangible assets typically consist of goodwill and possibly a covenant not to compete.
Purchase price allocation is a complicated, yet often overlooked component of business sales. For any questions related to purchase price allocations, or for any other legal questions related to Business or Estate Planning, please contact Fournier Legal Services by emailing firstname.lastname@example.org or by calling 860-670-3535.
Joseph E. Fournier is an Attorney and a CPA who has more than twenty years of experience in a variety of business legal matters, including start-ups and company formations, drafting shareholder and operating agreements, contracts, employment law, commercial litigation, tax planning and audit defense, and mergers and acquisitions (M&A). He also handles estate planning matters, such as business succession planning, wills, trusts, and probate.