December 10/17, 2018: Volume 34, Issue 14
By Roman Basi
When buying or selling a business, it’s vital to understand the role “basis” plays—whether it’s asset basis or stock basis—in the purchase price allocation and overall structure. Following are a few pointers on the interplay between an asset basis purchase and stock basis purchase.
Buyers generally favor an asset sale for the stepped-up asset basis, an upward readjustment of value in a fixed asset for tax purposes upon inheritance of such asset. This upward readjustment in basis allows the buyer larger asset depreciation and amortization, which, in turn, lowers the business’s taxable income. However, a seller will seek to allocate a lower value to its assets in an attempt to allocate the rest to company or personal goodwill. Under the seller’s preferred allocation, the buyer loses some of its stepped-up basis, thereby lowering his amount of depreciation and amortization.
Asset basis. Adjusted asset basis plays a vital role in the taxation aspect of a merger/acquisition. An asset’s adjusted basis is calculated using the asset’s original cost, then making adjustments upward based on investment into improving the asset or, more commonly, downward through depreciation, amortization and Section 179 deductions.
For example, let’s you purchase a machine for $50,000 and under the Tax Cuts and Jobs Act, you use bonus depreciation on the asset to reduce your business’s taxable income. An interested buyer approaches seeking to buy all the assets of your business; in purchasing the assets, the price will be allocated to your assets and likely some goodwill. If the asset price allocation exceeds the adjusted basis of your assets, you’ll be subject to a seller’s worst nightmare in the form of depreciation recapture—the gain received from the sale of depreciable property that must be reported as income. The gain reported as income is then subject to a higher income tax.
Stock basis. It’s important for a seller to be aware of the different stock basis calculations regarding an S-corporation and C-corporation. S-Corp basis calculations are more complex than those for C-Corps. The latter’s stock basis stays the same year to year, while an S-Corp’s basis is an annual moving target based on annual income, distributions and loans. It’s important to calculate and understand an
S-Corp’s stock basis as it is the cash shareholders can pull from the company without penalty.
From a selling standpoint, basis is the cash shareholders can obtain “without realizing income or gain,” which equates to the tax-free amount when the company is sold. An S-Corp’s stock basis will decrease when distributions are made to shareholders, or when deductions or losses take place. The stock basis will increase when capital contributions, ordinary income increases or investment income and gains are made. The value in having high basis when selling your business is paramount to minimizing tax liabilities.
There are times when sellers find themselves with a buyer who wants to purchase the selling company’s stock, but it would be more advantageous, tax-wise, for the seller to sell its assets. In certain situations, a Section 338(h)(10) election may be the answer. This allows the purchaser of the stock of an
S-Corp, or a corporation within a consolidated group, to treat the transaction as an acquisition of the assets for tax purposes.
Contact me for more personalized guidance on this issue.
Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners. For more information, please visit taxplanning.com.