How to Acquire an Asset Without Losing Out on Taxes
Updated on February 29, 2020
When it comes to buying and selling businesses, there is a lot to learn.
While it might be our calling to pour blood, sweat, and tears into the online/ecommerce biz, we know that not everyone has the time, energy, or interest to learn everything about acquiring assets and entities. It’s a ton of work.
To boot, there are the sneaky financial factors that must be considered before taking the leap and making a purchase, most often requiring the assistance of trained professionals.
Are you thinking what I’m thinking?
As a savvy business owner, you want to make sure that you’re doing things right when it comes to managing tax liabilities through an asset or entity acquisition. And the swelling pile of information uncovered by a simple Google search can be enough to make even the most valiant of QuickBooks experts shake in their boots.
The best way to conquer the tax dragon is familiarizing yourself with some background knowledge, then getting some professional help.
Whether you’re considering asset or entity acquisition in the near future or even just thinking it might be something good to do at some point in time down the road, you need to know what’s what first.
Why Hire a Tax Professional?
When preparing to buy a business, you should plan to hire a tax attorney, a Certified Public Accountant (CPA), or both.
While both types of professionals can provide tax planning support by assisting businesses and individuals in making choices based around potential tax benefits or penalties, each role has a slightly different purpose.
Tax attorneys have specialization in the legal questions about tax planning. In the context of an asset or entity acquisition, a tax attorney can review contracts, assist in negotiations, and advise on the tax effects of the deal. Also, any legal challenges or cases that arise afterward (such as an audit) would fall under the umbrella of a tax attorney.
On the other hand, CPAs focus primarily on the financial implications. When it comes to filing tax returns to the Internal Revenue Service (IRS), CPAs can prepare and file them directly. CPAs also have the background and ability to take a detailed look at the accounts of the company you want to buy to ensure that nothing looks out of order. They can also check into any of the company’s outstanding debts, and get a clearer picture of the status of the company’s assets, such as if they are owned, leased, or partially paid-for.
Depending on the kind of business purchase you’re planning to make (brick-and-mortar assets or an ecommerce business, for example), you may opt to hire one of these professionals locally or someone online/international who deals primarily in those types of acquisitions.
Buying and selling businesses is what we do, but we want to stress ever so strongly — we are not tax experts!
For this article, we talked with individuals at TaxJar, a company that automates sales tax calculations, reporting, and filings, as well as Bean Ninjas, which does bookkeeping in Xero for businesses in Australia, Canada, the U.K., New Zealand, and the U.S. As we break down some of the most important considerations of asset acquisition, we have included some pieces of general advice from those experts.
But again, when it comes to making decisions for your particular situation, we strongly advise seeking the help of a tax professional. We can’t say it enough.
With their help, the whole process can become a little less painful with a lot less stress.
Buying Assets Vs. Buying Entities — What Is the Difference?
When we talk about buying and selling businesses, the notion can seem a little amorphous … what does it actually mean when you buy someone else’s business? What does that include? Is there a 1-Click option?
Hate to break it to you, but the answer here is that it depends. Business sales and purchases can be structured in many different ways depending on the type of company/buyer, the industry, the method, and so on.
Despite the plethora of possibilities, generally your options fall into one of two camps:
Assets: Elements that comprise a business; usually broken up into three categories — tangible, intangible, and intellectual property.
- Tangible assets are just what they sound like — the things you can touch: equipment, vehicles, buildings, etc.
- Intangible assets have no physical form and include things like reputation, name recognition, and industry knowledge.
- Intellectual property is a subset of intangible assets, or the creative elements, such as brand names, inventions, logs, and the like.
Entities: The whole shebang — the entire business itself, or all the corporation’s stock shares or all the limited liability company’s (LLC) membership interest.
For example, if you want to purchase the storefront, equipment, and materials of your local coffee shop, but nothing else — that would be an asset purchase, not an entity one.
At this point, the advantage of buying an asset versus an entity might not seem readily apparent, or perhaps you already have your mind set on one or the other. You may have heard that as a buyer, an asset acquisition is more financially advantageous and has less risk or tax liability, or that you can garner a better price through an entity acquisition.
But when tax considerations are added into the equation, there are several factors to consider before you make a decision.
Things to Consider When Acquiring an Asset or Entity
As with most business deals, there are elements that favor one side over the other. Both the buyer and the seller walk into the potential transaction with expectations of what’s ultimately best for them individually.
Several elements should be considered before entering into any purchasing negotiation. Note that all of them can have effects on both the buyer and the seller.
Tax Jurisdiction
Things get tricky when you cross borders, be they state or international ones.
Meryl Johnston, founder of Bean Ninjas, says that it’s important to first clarify what makes sense given the tax jurisdiction the buyer is in, as tax laws will of course differ by state and country.
The United States, for example, is notorious for having a highly complex sales tax system.
Business Structure
Johnston also says that it’s most important to ask, “What is the most appropriate structure to hold the ownership of the business in?,” keeping in mind asset protection and tax minimization.
In the ecommerce realm, this may include any stock trading considerations, cost per unit, and how these will cross over into the new business.
For U.S. business owners, operating as a sole proprietor, an LLC, an S Corporation, or a C Corporation can each have pros and cons to evaluate.
Seller Goals
If a seller has put their business’ assets (or the entire entity) up for sale, there’s a reason for it.
Maybe they’re tired of running it and want to move onto other ventures, maybe they’re moving locations (in the case of a brick-and-mortar business), or maybe they’d like to make some money off of what they’ve accomplished so far. Whatever the case may be, the seller has a set of motivations for moving from owning to selling.
These intrinsic motivations — lack of energy, urgency, or desire to turn a profit, to name a few — may influence the nature of the selling process and how much you as a buyer stand to gain from the transaction.
For example, if you know that the seller would really like to get rid of the business quickly, you can use this as leverage to negotiate the price down closer to your target. If you have sold a business in the past, you may already be familiar with some of the usual goals of a seller. It helps to know these elements before you head into a purchasing decision.
Pros of Entity Acquisition
Buying an entity can have its pros.
Owning the entity makes it much easier to acquire the intangible assets such as patents and contracts, for one.
Entity acquisition may also help the buyer more quickly expand their reach by entering new markets more seamlessly.
In addition to those advantages, given the greater liability of purchasing an entity, you as a buyer may also be able to negotiate a better purchase price in that situation.
Pros of Asset Acquisition
Generally speaking, many first-time business buyers opt to purchase assets for the peace of mind of knowing that they will not inherit any of the business’ debts, be they from taxes or elsewhere. This option also gives buyers the freedom to purchase only selected assets of the business; in other words, buyers can acquire the specific assets they want — not the entire bundle of assets that comprise a company.
Cherry-picking asset sales is also referred to as a “partial exit,” meaning that a business can sell off some of its assets in efforts to streamline, spin off, or move toward total liquidation of the company.
In addition, asset purchase allows the buyers to allocate the purchase price among assets, reflecting their fair market value. Because the tax basis for each individual asset will be whatever was paid for the asset, the buyer can claim asset depreciation on tax returns, resulting in tax savings.
Buying an entity, on the other hand, carries more financial risk, as the company could have outstanding financial debts that the new owner would have to take responsibility for.
Since asset sales are one of the cleanest and simplest ways to buy another business, they are generally recommended for businesses under the $10 million mark.
All deals on the Empire Flippers marketplace are structured as asset purchases.
Minimize Your Liability
As we mentioned above, the absolute best way to ensure that you don’t run into any trouble is to hire a tax professional to help you. It’s a message that bears repeating.
Depending on the type of business you aim to acquire, you may wish to seek out a local professional or one that works mainly in ecommerce so that they best understand any considerations specific to your situation.
Given the advantages of purchasing assets, you may conclude that it’s a safer route to take.
However, if you do decide to make the leap and move forward with purchasing an entity, there are a few things that the tax professional you hire will recommend you do to minimize your liability — since in buying an entity, the purchaser is effectively buying the history of the company too, including loans, liens, and lawsuits.
Perform a Uniform Commercial Code (UCC) Search
Every state has a UCC database that allows you to search what creditors have filed against a specific debtor, in this case the entity you want to purchase, in that state. You can do this search in every state in which the company has done business to see what kinds of debts are out there.
This knowledge can help you catch any red flags of a potential purchase by making sure you have a better financial picture of the business.
Call the IRS’ Tax Lien Department
The IRS is a good place to start searching to find out if any tax liens are affecting the business you want to buy. To do this kind of search, you’ll need the business owner’s name and Social Security number. Using this same information, you can contact the county clerk’s office, and even run a background check.
Similarly, you can also call and ask the state tax authority for a certificate of tax clearance stating that the seller is current on sales and use taxes.
Jennifer Dunn of TaxJar attests that this step is important when it comes to sales tax, as potential buyers should check whether the business owes sales tax to a state(s), and see if the business has been sales tax compliant in the past.
In California, for example, a buyer is responsible for obtaining a certificate of tax clearance before they purchase a business. Dunn says, “If the certificate is not obtained and it later turns out that the business owes sales and use tax, then it’s up to the new buyer to pay the amount due. This can be a very unwelcome surprise and mean unexpected expenses for the buyer.”
Sit Down and Talk with the Seller
Even if you are buying a business online, nothing can quite replace a face-to-face conversation when it comes to building trust and hashing out any lingering doubts or concerns regarding the sale of a business.
To be extra careful, you could have the seller outline all outstanding debts they are aware of, and then have an attorney draft a warranty or an indemnity stating that if any outside debts arise, the seller will make good on them.
Risks and Rewards: Acquiring Assets and Entities
As a business owner, an entrepreneur, or an aspiring asset or entity purchaser, there is certainly a lot to take into account before making the leap — especially when it comes to the tax implications associated with the process.
The number one way to ensure you don’t lose out on taxes is to hire a professional who can do just that — a CPA, tax attorney, or both.
For your own knowledge, before purchasing, make sure that you first understand the key differences between assets (tangible, intangible, and intellectual property) and entities (the entire business itself, or all the corporation’s stock shares or all the LLC’s membership interest), as well as the risks and rewards of both.
These considerations can include the tax liabilities and advantages for both the buyer and the seller, as well as each individual’s or company’s goals.
Beyond hiring a tax professional, you can also take several steps to protect yourself as much as possible, including performing UCC searches, checking on any tax liens, and talking to the seller directly.
Whatever you choose, the more you can learn beforehand, the better off you’ll be.
Photo credit: PTStock