Nashua business owner has concerns about how to avoid (or minimize) being “double taxed” when he sells his business that has been operated as a C-corporation
Selling a business requires careful tax planning; especially where a business has operated as a closely held C corporation and the proposed structure of the deal is an asset sale. However, opportunities still exist for the selling owner to significantly reduce his or her tax liability on the sale of the business by selling his or her “personal goodwill” associated with the business separately from the business’s assets.
By way of background, a taxable sale of assets by a C corporation, followed by a liquidation or distribution of the sale proceeds to shareholders, normally results in a double tax at the corporate and shareholder levels.
Double taxation can be avoided if the transaction is structured as a stock deal, with the shareholders selling their stock in the corporation. However, a purchaser may prefer an asset deal for at least three reasons, including:
- In an asset deal, the purchaser gets a stepped-up, fair market value basis in the acquired assets equal to the price paid and any liabilities assumed (the purchase price), and will therefore get higher depreciation and amortization deductions than the target corporation was enjoying.
- Unlike in a stock deal, which takes the target corporation with all its liabilities, known or unknown, an asset deal allows the purchaser to select which liabilities, if any, it will assume.
- Similarly, an asset deal allows the purchaser to select which assets it will purchase, rather than, as in a stock deal, all of the target corporation’s assets, wanted or unwanted.
Few strategies are available for avoiding the double tax cost from a taxable sale of assets. The most frequently used strategies involve payments directly to the shareholders under employment, consulting, and noncompetition agreements. While payments to the shareholders under those agreements will be taxed only once, at the shareholder level, those payments will constitute income to the shareholders taxable at ordinary income tax rates, and the employment and consulting payments will be subject to employment taxes as well.
Another strategy involves a shareholder’s sale of the personal goodwill (defined below) associated with the operation of the corporation. For the strategy to work, it must be demonstrated that goodwill in fact exists, that it is both salable and separately transferable to a purchaser of the corporation, and that it is personal goodwill owned by a shareholder rather than business goodwill owned by the target corporation itself.
Executive Summary – Personal Goodwill:
- When a corporation is sold in an asset sale, a separate sale of a shareholder’s personal goodwill associated with the corporation can result in the gain from the sale of the goodwill being taxed to the shareholder at more favorable long-term capital gains rates.
- In appropriate situations, and after detailed valuation and analysis by the selling companies CPAs and transactional attorneys, personal goodwill can be present when the owner’s reputation, expertise, skill, knowledge, and relationships with customers are critical to the business’s success and value.
A sale of corporate assets and personal goodwill should be carefully planned and executed to establish that personal goodwill exists and that it is being sold in a separate transaction from the sale of the assets of the corporation.
At Welts, White & Fontaine, P.C. our lawyers have experience representing buyers and sellers of closely held businesses. We can help you develop strategies for a successful navigation of New Hampshire’s business planning and succession landscape. Please contact Attorney John Polgrean if you have questions or concerns about your buying or selling a business or your business succession planning endeavors. (603) 883-0797. firstname.lastname@example.org
Author: Attorney John Polgrean
This blog is intended for informational use only. The information contained herein should not be construed as offering legal advice or a legal opinion.