When selling a business, the buyer and seller are often at odds on determining the structure of a transaction for the best tax advantage. The buyer will generally prefer an asset sale, while the seller usually prefers a stock sale, because closely held C corporations and certain S corporations will incur double-taxation to the seller when the corporation is sold as an asset sale. To avoid double-taxation, consider an alternative option: purchasing the “personal goodwill” of the seller.
Purchasing the Personal Goodwill of the Seller
A strategy that should be considered by the two parties is separately purchasing the personal goodwill of the selling shareholder. Personal goodwill exists when the owner’s reputation, expertise, skills, knowledge, and customer relationships are large contributors to the business’s value and ongoing success. Personal goodwill also exists when there is a possible likelihood that customers may follow the owner rather than the company when the business is sold.
Personal Goodwill Escapes Double Taxation
The portion of the total sale amount determined to be personal goodwill will escape double taxation, as it an asset purchased in a separate agreement directly from the shareholder. The sale of the personal goodwill will be taxed once at the shareholder level using the capital gains rate. The remainder of the sale price is allocated to assets purchased from the business entity. Gain on the assets purchased from the business entity will cause taxation at the C corporation level; then is taxed again at the shareholder level upon the distribution of proceeds or liquidation of the entity.
Calculating Personal Goodwill
Determining the percentage of the sale price allocated to the shareholder’s personal goodwill requires advanced planning and should be well-documented. It is advisable to contact a tax advisor to work with an experienced and credentialed business appraiser to determine the value of the personal goodwill.
The use of personal goodwill is one of many strategies that should be addressed by business owners well in advance of transitioning their business. Find out more about Anders Business Transition Planning Services or contact an Anders advisor to discuss personal goodwill and other ongoing educational opportunities for business owners.
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