The information in this article is up to date through tax year 2019 (taxes filed in 2020).
Whether you’re buying your first business or have a few already, there are fundamental guidelines to follow when considering the tax implications of such a large transaction. Before signing a deal, research the financial history of the business to determine how potentially profitable or burdensome a purchase could be.
There are two main types of buying in this arena: a stock purchase or an asset purchase. Sellers prefer stock transactions because they will receive more tax benefits. Asset purchases are more beneficial to buyers because the fear of hidden liabilities is eliminated. Don’t forget about the basics as you enter the purchasing arena.
Review financial history: When taking into account the reasons for buying a specific business, you or your most trusted financial advisor will need to take a deep dive into the history of the business. In addition to reviewing obvious information such as balance sheets and cash flow statements, take a look at federal, state and local tax returns.
Know local and state tax liabilities: Depending on your state of purchase, a buyer may not be able to conduct business until local and state tax debt is paid off. So, what taxes do you owe? That depends. If you require the seller to show evidence that all tax debt has been paid, you are in the clear. Yet, if there are taxes due after the purchase, you may be responsible for a portion of them. It’s important to note that money owed to the federal government is the responsibility of the seller.
Assessing the assets: When you purchase assets, the tax implications depend on the purchase price, and the amount of tax liability you acquire depends on the types of assets – whether they produce ordinary expenses/income or capital losses/gains. You and the seller will most likely enter negotiations because he or she will have different motivations, such as allocating prices to non-depreciable assets to decrease his or her costs. Meanwhile, you’ll be focused on the ordinary assets that will allow you to write off more business expenses – and therefore earn more tax deductions – in the future. Prior to negotiating, do your research to maximize your gain for this transaction. The instructions on IRS Form 8594 include seven classes of assets:
- Cash and bank deposits
- Actively traded personal property and certificates of deposit
- Debt instruments
- Stock in trade (inventory)
- Furniture, fixtures, vehicles, etc.
- Goodwill of a going concern
Thinking through employment tax: Although this varies by state, employment taxes are typically deductible for business owners. If a seller is willing to remain on board to provide training at the purchased business, buyers can reduce their tax liability by negotiating a lower selling price for a higher wage during the training period.
Ultimately, information is king. To make smarter purchases, you need to know what to expect during and after a purchase. If you’re a small business owner, familiarize yourself with Publication 334, a tax guide from the IRS for individuals who use Schedule C.