Selling a business is a complicated transaction.  The long list of business and personal issues that need to be considered is extensive and at times, confusing.  Usually at the top of the list is the tax the seller will pay when the business sells.  When selling a business, properly structuring the transaction will minimize taxes owed;  ordinary tax rates for corporations are 21% and capital gains tax rates range from 15% to 20%. 

A taxable sale of assets by a C corporation or an S corporation with profits, where the proceeds will be distributed to the shareholders, typically results in a double tax at the corporate and individual tax levels. If strategically structured, the sale of goodwill will only be taxed once, at the individual level and at the lower capital gain rate. (Related article: Notice to All Business Owners)

Goodwill
Usually included in the sale of a business is goodwill.  Goodwill is an intangible asset defined by the Regs. Sec. 1.197-2(b)(1) as “the value of a trade or business attributable to the expectancy of continued customer patronage,” and that “this expectancy may be due to the name or reputation of a trade or business or any other factor.” 

According to the (Rev. Rul. 59-60), the value of a company’s goodwill is determined by a many factors, including:

• earning capacity
• prestige of the business
• ownership of a well-known and respected trade name
• a record of successful operation over a prolonged period of time

Goodwill is typically considered a business asset but recent Tax Court decisions have suggested that goodwill can be a personal asset, thereby allowing the sale of goodwill to be considered a capital gain and taxed at a much lower rate and only once.

How it works
The asset sale of a corporation will cause ordinary income to be incurred and taxes paid by the corporation. 

• When the selling corporation distributes the sales proceeds and closes its doors, the shareholders of the corporation will be taxed on their capital gain income (their share of the sales proceeds over their tax basis in the corporate stock). 
• The corporation will pay roughly 21% tax and the individual will pay capital gains tax at either the 15% or 20%, depending on the shareholder’s personal income tax bracket.
•  If the goodwill of the business is actually personal goodwill, the sale of goodwill will not be taxed at the corporation, but instead will only be taxed at the individual/shareholder level.

Courts have held that goodwill may be considered a personal asset (and not an asset of the business being sold) if the earning power of the business is directly related to the business abilities and personal relationships of the owner.

Personal relationships of a shareholder/employee are not corporate assets when the employee has no employment contract with the corporation. 
For example, in 1988, the Norwalk Court found that the clients of the accounting corporation’s business were loyal to the individual accountants and it was “reasonable to assume that the personal ability, personality, and the reputation of the individual accountants are what the clients sought.” Norwalk, T.C. Memo. 1999-279

As all business owners know, the key to success is based on the strong relationships and quality of products and services of the business.  In most cases, the relationships built by the owner of the business drive the success.  With guidance from the courts, owners who are selling a business can save on their taxes if the sale is structured properly.

Zinner & Co. has a proud history of working with and advising private business owners for over 80 years. We have the experience to ensure you are in the most favorable financial position when buying or selling a business.

To learn more about buying or selling a business, or to schedule a no-cost consultation, contact us at (216) 831-0733.

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