The tax status of the sale of business a complex issue
Q: About five years ago, I bought the assets of a company for $ 2.2 million. The seller and I have filed an IRS Form 8594 to show how this cost was allocated to specific assets. The contract required us to report the same allowance to the IRS. This included $ 800,000 to goodwill and $ 220,000 to customer lists. I amortized both costs over 15 years. I am now selling the assets for $ 3.4 million. We are also in the process of concluding a cost sharing agreement. The buyer doesn’t think anything should be assigned to the customer lists. The draft agreement allocates $ 1.9 million for goodwill. I will have a significant tax gain either way, but I claimed $ 280,000 in depreciation deductions for goodwill, so this allocation will create $ 1,380,000 in gain just for goodwill. I am prepared to do so if the tax law allows the application of a favorable rate. I have been told that goodwill is a capital asset and that I will have a capital gain. This would be taxed at 20% for me and the 3.8% investment income tax should not apply. It’s my retirement and if the tax cost is much higher I’m not sure I can go along with this deal. Can you at least give me an idea of how this will be taxed?
A: You need to hire a knowledgeable advisor to look at this case from a holistic perspective and provide specific advice. I’ll give you an overview and include a tax law quote that might save your advisor time.
Also, please understand that there are many issues associated with selling a business and I can only address the very limited issues you raise.
Subject to this caveat, I will make a few observations. First, the biggest issue you raise is the nature of the gain from the sale of goodwill. Taxpayers use the word “person” to refer to ordinary income or capital gain.
The tax legislation allows the application of a favorable rate to certain types of income, in particular what is called a “net gain (GNC)”. An NCG can include a long-term capital gain as well as a “Section 1231 gain”.
The sale of a capital asset held for more than one year can produce a long-term capital gain and the sale of a Section 1231 asset a Section 1231 gain. Both types of gain can benefit from an advantageous rate. .
Capital losses can only be used to offset capital gains and are otherwise limited to $ 3,000 per year. Losses under article 1231 are allowed without limit.
Some people say that the assets in Section 1231 produce “the best of both worlds”. The gains and losses are tax advantageous. This is important to you because your goodwill is a Section 1231 asset rather than a capital property.
Section 1231 property is depreciable property used in a trade or business or any real estate (i.e. even land) used in a trade or business. Section 1231 property must be held for more than a year to qualify, so there is no long term or short term in the definition.
Goodwill is “amortizable” because it is an intangible asset. Only tangible property can be depreciated. In the pure sense of the term, goodwill cannot be amortized.
The tax regulations (1.197-2 (g) (8)) nevertheless stipulate that goodwill will be treated in the same way as depreciable assets. This is therefore a Section 1231 asset rather than a capital asset. It also means that any previously claimed depreciation can be “clawed back” as ordinary income.
Your proposed gain of $ 1,380,000 will be a section 1231 gain, but $ 280,000 will be taxed at regular tax rates. This is so because the $ 280,000 in capital cost allowance reduced your previous tax to regular rates. This prior benefit of $ 280,000 is then “clawed back” as the same character.
The approximately $ 143,000 remaining in your client list can be claimed as an ordinary loss under section 1231. You could claim an allowance of $ 143,000 from client lists if you believe that claiming a loss could do so. eyebrow the IRS, but it’s probably not necessary.
The 3.8% surtax on investment income should not apply to your earnings. This is so because the assets sold were business assets rather than investments.
Jim Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected]