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The owner of a service company that installs and maintains heavy equipment for commercial buildings was interested in selling his company and had found a buyer. The seller knew the buyer and was confident his company would be in good hands. However, the buyer did not have cash available to purchase the company up front, so the seller agreed to accept an installment note in lieu of cash.
A stock sale would have been the most beneficial to the seller because it would allow the entire sale to be taxed at the lower capital gain rates and avoid some of the problems (discussed below) that are involved with assets sold under an installment note. At the same time, a stock sale would not have been attractive enough to appeal to a buyer because it would not offer the significant tax deductions available under an asset sale*. As such, the best course of action (and the only course of action for the seller) was an asset sale.
The owner, a longtime client of WBL, asked the firm to review his deal and identify any tax-related issues. Upon review, WBL identified two potential barriers to the transaction:
Because the seller had fully depreciated his fixed assets, his overall net tax basis in the assets of the company was very low but he had significant stock basis due to the cumulative earnings of the company. Therefore, the asset sale would generate a much larger gain due to the agreed-upon purchase price allocation and thus a much larger tax liability than a stock sale.
Assets and liabilities transferred in the sale include fully depreciated fleet vehicles and their notes-payable. Tax rules require that transfer of these assets and liabilities be recognized as additional income to the seller in the initial year of sale rather than over the life of the installment note. Therefore, as a result of the installment sale, the seller would not receive enough cash in the first year to cover his first-year tax.