Practice Transitions – Buying and Selling a Business (Part I)
Chris Hussey, Tax Senior Manager
There is no worse feeling for an advisor than receiving a call from a longtime client stating that he or she just sold a business, unless it is a call from a client instead indicating he or she just bought a business! If done without the input of a tax advisor, many problems can result that easily could have been avoided, and unfortunately, this happens more often than one would think. One of the parties to the transaction may not have realized the tax implications of the structure chosen, and find out about it too late to alter an unfavorable outcome.
In this two-part article, we will address the pros and cons of three of the most common structures for transitioning a business. The first will be presented from the seller’s perspective, and the second will be presented from the buyer’s perspective.
Part I - Practice Transitions From the Seller’s Perspective
The seller’s top priority is to maximize the return for the business that they have spent years building. Thus, sellers should be sure that the financial records of the business are in order. In some cases this means planning for the sale a few years ahead of time.
Generally we advise larger business owners that they need 3-5 years of audited or reviewed financial statements prior to selling their business. While not every business needs to go through the time and expense of having audited financial statements, when the time comes to sell your practice, audited or reviewed financial statements may be well worth the time and money.
With audited statements, buyers are typically more willing to purchase a practice, and pay a higher price than they might for a practice whose profit and loss is determined by simply compiling receipts at year end. This is due to the added confidence the buyers have in the accuracy of the books and records.
Let’s examine the most common types of practice transitions and discuss their pros and cons from the seller’s perspective.
The stock (or partnership interest) is purchased directly from the seller.Seller Pros
- Seller reports all or most of the gain as capital gain, qualifying for preferential tax rates.
- Any liabilities stay with the entity, releasing the seller from any future liability.
- Sales price is generally lower due to buyer’s awareness of tax savings for the seller.
- Potential loss of tax attributes – certain losses and credits stay with the entity, to be used by the buyer.
- Fewer buyers are willing to use this method due to the liability issues.
The assets of the selling entity are sold directly to the buyer.Seller Pros
- Generally a higher sales price, because benefits applicable to buyers motivate them to pay more.
- If there are prior year losses or tax credits, they could be used to offset the gain by the selling entity.
- More of the gain is likely to be taxed as ordinary income instead of long-term capital gain.
- There is potential for double taxation if selling entity is a corporation. The corporation may pay tax on the gain on the sale and the shareholder could be taxed on the resulting distributions from the entity.
- Liabilities of the selling entity stay with the selling entity, which is still owned by the seller.
This is a stock sale with an election made by both parties to treat the sale as an asset sale for tax purposes.Seller Pros
- For some entities, the seller pays $0 in taxes, because the buyer (as legal owner of the entity) bears the burden of the seller’s taxes.
- Liabilities are released and assumed by the buyer (because legally, the stock was sold, and the liabilities stay with the company).
- Generally results in a lower purchase price relative to a pure asset sale, because the liabilities are assumed by the buyer.
- Loss of tax attributes, if any, as they would stay with the entity for use by the new owner.
This concludes our discussion of matters from the seller’s perspective. In our second part of the article, we address matters from the buyer’s perspective.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.