Allocation of the Purchase Price in Sales Transactions

As a lawyer, I deal with a lot of important tax and non-tax issues for my clients in business transactions. Some of these issues include things like warranties, indemnification, and restrictive covenants. One important issue that often gets overlooked is the allocation of the purchase price in a transaction, which is required by the tax code. This article explains why this is important and how it affects clients, especially with recent changes in the tax law. In 1986, a new tax law changed how businesses were bought and sold. Asset purchases became more popular because the buyer would get a tax break on the purchase price. Before, only certain assets could be written off for tax purposes. Sellers would inflate the value of these assets to get more tax breaks. But important things like customer lists and intellectual property were undervalued. Section 1060 of the tax code requires that when a business is sold, the buyer and seller have to decide how to divide up the sale price among the different assets being sold. This can be a complicated process and has caused problems in the past, leading to disputes with the IRS. However, in 1993, a new law was passed that made the process easier by allowing certain assets to be spread out for tax purposes over 15 years. This has helped reduce disputes and uncertainty in business sales. Basically, even though a §338(h)(10) election isn’t technically an asset sale, it’s treated like one for tax purposes. This election can be made when a corporation buys at least 80% of another company’s stock. Once the election is made, the transaction is treated as if the buyer purchased all of the company’s assets, and the purchase price is allocated using the residual method, similar to how it’s done under §1060. In simple terms, there are some differences between an asset sale and a deemed asset sale under tax law. For example, the rules are different when it comes to selling real estate. The law is more clear for transactions involving a business, but not so much for real estate sales. ABC Corp is selling its trucking business and terminals to BuyCo, Inc. The sale includes tangible assets and real property. If the terminals are owned by separate LLCs, the sale would involve multiple agreements. The sale of the trucking business would require an allocation of the purchase price, but the sale of the real property would not. This could lead to differences in how the real property is valued, especially if BuyCo, Inc. wants to do a cost segregation study for tax purposes. When two companies buy and sell property, they have to figure out how to divide up the money for tax purposes. The values of the land and buildings are important because they affect how much tax each company has to pay. The companies can negotiate and agree on how to divide up the money for tax purposes, but they have to follow certain rules. If they don’t agree, they might report the sale differently and pay different amounts of tax. Section 1060 is a provision that deals with how the purchase price in a business acquisition is divided among different types of assets. It says that if the buyer and seller agree in writing on how to divide the money, then the IRS will accept that agreement unless they think it’s not fair. The provision also specifies seven categories of assets and how the purchase price should be split among them. These categories include things like cash, inventory, and intangible assets like trademarks. The idea that both the buyer and seller have to report the same purchase price allocation on their taxes is not true. They have to give the IRS certain information on Form 8594, but if they don’t agree on the allocation, they can file different amounts. However, if they do file different amounts, the IRS might check up on them with an audit. This can be avoided if they agree in writing on the allocation. If they can’t agree, they should have evidence to support their allocation. If the purchase price of a business changes after the sale, the buyer and seller must report it to the IRS. This can happen because of things like working capital adjustments or earnouts. If the increase happens after the sale, the buyer and seller need to file a supplemental form. The increase should be distributed among the different types of assets based on their fair market value. If the purchase price decreases, the allocation of the price should be reversed. If an asset has been sold or used up, no decrease can be allocated to it. It’s a good idea to include language in the purchase agreement to cover any changes in the purchase price and agree to file a supplemental form if needed. The TCJA has changed the rules for tax deductions on business assets, which means that buyers and sellers need to pay attention to how they allocate the purchase price of those assets. This can have a big impact on the taxes they have to pay. If you’re involved in a business deal, make sure to discuss this with your accountant and lawyer to make sure you’re getting the best tax benefits. These are references to specific sections of the United States tax code and regulations. They are used to discuss rules and requirements related to business transactions and tax planning. The author is a lawyer who specializes in corporate law and taxes. The column was written on behalf of the Tax Law Section.

Source: https://www.floridabar.org/the-florida-bar-journal/allocation-of-the-purchase-price-in-sales-transactions/