Buying a Business: How to Make Tax-Smart Price Allocations
When you are buying a business, you want to buy not only at the right price, but also in a manner that keeps your taxes as low as possible.
One of the variety of ways to buy the new business is with an asset purchase:
An asset purchase generally allows you to avoid exposure to unknown or undisclosed business liabilities.
The tax basis of the assets can be stepped up (increased) to reflect the purchase price that you pay for the business. The step-up gives you bigger depreciation and amortization deductions for buildings, furniture, equipment, and intangibles and reduces taxable gains when assets like inventories or receivables are sold or converted into cash.
In an asset purchase, you allocate the total purchase price to the specific assets that you acquire. The amount you allocate to each purchased asset becomes the tax basis of that asset. This gives you tax planning and negotiating opportunities.
With an asset purchase deal, the most important tax-saving opportunity revolves around how you allocate the total purchase price to specific assets. To the extent possible, you want to allocate more of the price to
assets that generate deductions against ordinary income (such as inventory and receivables),
assets that can be depreciated relatively quickly (such as furniture and equipment), and
intangible assets (such as software, customer lists, and goodwill) that can be amortized over 15 years.
As the buyer of business assets, you (or your business entity) must independently report to the IRS—as must the seller (or his or her business entity)—the purchase/sale price allocations that you and the seller use. You do this by attaching IRS Form 8594 to your respective federal income tax returns.
If the IRS sees different allocations from the buyer and seller, this raises the risk of an audit. I would recommend that you consider including in any asset purchase/sale agreement a requirement that the agreed-upon allocations be reported on the respective IRS Forms 8594.