By Greg Saunders, CPA/ABV, ASA | Business Valuation and Forensic Services Manager
Buying or Selling a Business? Asset Deals Become More Attractive Under Tax Cuts and Jobs Act
Two options exist for those considering a business transaction
1) Buy/sell the assets of the business
2) Buy/sell the ownership interests in the business
Generally, prospective buyers favor purchasing the assets of the business, while sellers favor transferring ownership interests. Buyers often prefer asset deals due to their ability to step up the tax basis of assets when transferred, resulting in larger depreciation and amortization deductions and lower taxable gains when certain assets (e.g. inventory) are sold. Furthermore, buyers want to minimize exposure to unknown or undisclosed liabilities of the purchased business, which would typically be assumed under a purchase of ownership interests. On the other hand, sellers may want any liabilities related to the business to be transferred to the buyer with the sale. With regards to tax implications for sellers, any gains on the sale of ownerships interests are generally treated as long-term capital gains at lower tax rates with some exceptions for the sale of partnership interests. Additionally, the selling shareholders in C Corporations may be subject to double taxation under an asset sale. As you can see, many factors exist that may cause a prospective buyer or seller to prefer one transaction type over the other.
On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law which included several tax law updates that increased the attractiveness of asset deals, including the following:
Bonus Depreciation Provision
The TCJA included a provision that allows for 100% expensing of short-lived capital investments and certain qualified improvement property through 2022, which is then phased out between 2023 and 2026. This provision is extremely beneficial for business purchasers in asset deals which will have a stepped-up tax basis in these assets.
Reduced Individual Tax Rates
The TCJA temporarily lowers individual income tax rates, including the top marginal rate, from 39.6% to 37%. This provision of the TCJA is temporary as it sunsets in 2025, with tax brackets and rates reverting to 2017 levels in 2026. The reduced individual tax rates not only benefit individual owners of pass-through entities (PTEs), but may also benefit the individual sellers in asset deals to the extent that gains on the sale of assets are treated as ordinary income (e.g. depreciation recapture).
Flat 21% Corporate Tax Rate
The TCJA permanently lowers the corporate income tax rate to a flat 21%. This provision reduces the tax burden for selling shareholders in C Corporations that face double taxation under an asset sale.
Qualified Business Income (QBI) Deduction
The TCJA enacted a 20% deduction of QBI by individual owners of certain PTEs for the years 2018 to 2025, limited to the greater of 50% of wage income or 25% of wage income plus 2.5% of the cost of tangible depreciable property. Specified service business are not eligible for the deduction unless they meet certain income thresholds. These specified service businesses include: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. Again, this provision reduces the tax burden for individual owners of certain PTEs. Moreover, the QBI deduction may also benefit sellers in asset deals if any gains on the sale are treated as ordinary income due to depreciation and amortization recapture rules. Such gains qualify as QBI, while capital gains from the sale of ownership interests do not qualify.
As referenced above, the tax law changes under the TCJA have been more favorable to asset deals relative to transactions of ownership interests. However, in certain circumstances elections can be made to allow for corporate stock purchases to be treated as asset purchases for federal income tax purposes. In addition, buyers of interests in partnerships and LLCs treated as partnerships can elect to step up the tax basis of the assets under a Section 754 election. These assets with stepped-up basis are then eligible for first-year bonus depreciation for the buyer.
As a result of the factors discussed above, concessions may be necessary for both the buyer and seller to find acceptable common ground to complete a transaction. If you are in need of transaction advisory or business valuation services, please contact your Keiter representative or our Valuation and Forensic Services team.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.