What's the Big Deal?
The 1986 Tax Reform Act repealed to so-called General Utilities Doctrine which allowed corporations to liquidate and distribute the proceeds to the shareholders without incurring a double tax. The general thrust of this provision was to allow corporations to sell substantially all of their assets and, within a prescribed time distribute the sales proceeds to their shareholders. Assuming the corporation met the technical requirements, it incurred no tax on the transaction. The shareholders reported as income the amount they received in excess of the basis in their stock.

Current law provides that when a corporation sells assets, it must recognize a gain to the extent the sales price exceeds its basis in the assets sold. If a corporation subsequently makes distributions to shareholders, whether or not in liquidation, current law imposes a second tax. This two-tired tax structure significantly increases the tax cost of an asset sale by the corporation.

Generally, the Seller of an incorporated business prefers to sell stock because of the single level of income tax. Also a stock sale is easier to structure mechanically since it involves only a single asset. For employees, a sale of stock will result in the continuation of employee benefit plans unless the plan is specifically terminated and plan assets are distributed to the participants.

Conversely, the Purchaser of a corporate enterprise almost always wants to acquire the business assets. There are several reasons for this approach. The buyer can specifically identify only those assets which he wants to acquire and he will receive a step-up in basis to reflect fair market value for depreciation or amortization.

While he may by choice also assume business liabilities connected with those assets, he will not assume any contingent or unassertive liabilities of the selling corporation.

For tax reporting, the Internal Revenue Code permits installment reporting for both asset sales and stock sales which are not publicly traded property.

We have tax law which also affects the stock vs asset sale decision see the information about the 1993 Revenue Ruling Section 197.

Deducting Intangible Assets.
Under prior law, the tax code created a great incentive for the buyer to find ways to convert non-deductible "Goodwill" into deductible intangible assets such as covenants not to compete and large management contracts. The IRS then challenged these deductions. The 1993 Revenue Code Section 197 covers amortization of intangibles related to business sales. Basically, all "purchased" goodwill of any kind is now deductible over 15 years.

Covenants not to compete are deductible over 15 years, regardless of when the actual payments are made.

Management contracts to the extent they are for the preservation of the value of the company are deductible over 15 years, regardless of when the actual payments are made. The only current deduction is "reasonable" compensation for the actual services rendered. Because this is so difficult to define, it would seem to have great potential for future conflict with the IRS.

Customer lists are deductible over 15 years.

Goodwill currently on a company's books is not deductible. This means that most stock sales will not generate deductions for intangibles the way asset sales will.

The new tax law affects the overall value of a business to the extent that the net present value of the tax deductions may have been reduced by extending amortization over 15 years without being sufficiently increased by the new deduction for goodwill.

This new tax law favors asset sale structuring.

What Is Depreciation Recapture?
A known deal breaker for asset sale structuring is the Depreciation Recapture (built-in gains) that a seller has to pay.

A former C corporation which makes an S election is subject to a corporate-level tax if it sells appreciated assets during the first 10 years that the corporation is an S corporation (under Internal Revenue Code 1373). The code defines the term "built-in gain" as the excess of the total value of all of the C corporation's assets on the day it became an S corporation over the C corporation's tax basis in all such assets on that day (i.e.. the gain).

The build-in gain provision applies only to recognized gain. This corporate-level tax may be avoided by deferring the recognition of gain beyond the 10-year period. Deferral may be achieved, for example, by holding the property under a lease arrangement rather than transferring ownership.

Note that the selling tax payer must always report depreciation recapture as income in the year of sale, regardless of the cash received in the transaction. This is one area where the installment sale will not defer the tax due and if not carefully negotiated, the seller may be subject to an income tax liability which exceeds the cash proceeds in the initial year.

Tell Me About Contingent Liabilities.
Should the parties agree on a stock transaction, then Contingent Liabilities come into play The liabilities of a business are usually one of the most fiercely negotiated aspects of a deal.

In a stock transaction, the purchaser acquires all the baggage that the seller has accumulated - both good and bad - including those liabilities which may exist but have not yet been asserted. Sales negotiations may include partial or full indemnification agreements with offset rights or other forms of guarantees or participation by the seller of the business. However, it is a fact of life that getting the cooperation or financial participation of the Seller is difficult once the transaction is done.

A potentially tremendous liability that may never disappear involves environmental issues. Generally, any entity ever connected to the property as owner, lessor, lessee, etc., may be responsible for clean-up costs. It is virtually impossible to estimate the amount of this liability with any real accuracy. An environmental study performed by a reputable firm is absolutely imperative before entering into any sort of real estate contract for sale, acquisition or lease.

Another significant deal breaker is the landlord. Keep in mind that a landlord is being asked to take on a new risk and is not particularly motivated to even consider a new business owner. Not only are you an unknown quantity, but you are also higher leveraged than his current tenant.

Assuming you have enlisted the help of NVST.com experts and you have targeted a business, the first step to take the business off the market and to proceed with investigations of their records is a non-binding letter of intent.