M&A DO’S AND DON’TS – Purchase Price Allocations
An accountant seeking to assist their seller client in concluding a successful transaction needs to be mindful of the impact of purchase price allocations agreed upon between seller and buyer which is a process of determining various types of assets being purchased and what the buyer is paying specifically for each asset category. The IRS also requires a seller and buyer to agree on the allocations as filed on a specific form filed with the buyer’s and seller’s tax returns.
Generally speaking, a buyer will want to attach a higher value to tangible assets such as vehicles, equipment and furniture and fixtures rather than to intangible assets such as l, customer lists, trademarks and goodwill. The basic reason being that tangible assets can be depreciated/written off immediately in the year paid whereas intangible assets get amortized over a 15 year period. The tax savings difference can be substantial so it is always something to be cognizant of when negotiating the terms of a deal.
In addition to the tangible vs. intangible tax write-off analysis, the issue of depreciation recapture comes into place as it changes the character of taxable gain as between capital gains and ordinary income. Capital gain income incurs a lower tax rate than ordinary income and the distinction can be about 20%. If a seller has fully depreciated their tangible assets then any purchase price allocation to such category will result in ordinary income recognition to the extent of depreciation already claimed for this asset class; ergo the term “depreciation recapture.” Therefore knowing this is important to understand before agreeing on a sales price and the underlying allocation.
Finally, purchase price allocated to the tangible asset category may attract a sales tax therefore requiring an agreement between the seller and buyer as to who has to bear this cost of the deal. It is not automatic that the buyer pay the sales tax the way he would if he were purchasing a vehicle from an auto dealer. It is something to be negotiated and many buyers seek to push this responsibility onto the seller which, if successful, is essentially a reduction to purchase price. As this is part and parcel of the transaction, a seller should understand the impact that his after tax sale proceeds from the transaction will be less if buyer were to shift this tax burden to seller.
Check out our video on Drafting the Purchase Price Agreement
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