Dealing With Tax Professionals To Achieve Improved Compliance With The Laws

The majority of taxpayers in EU countries use tax professionals in some shape or form, and for this obvious reason the EU tax administration recognises that they play a very important role in their tax system. As well as helping to make the system run smoothly, they play a key role in influencing and shaping the tax compliance behaviour of their clients. This influence may be positive or negative, because of their professional knowledge of our tax system and its nuances.
Through their representative bodies, tax professionals also have an important role in developing our tax system. They are influential in forming public opinion and general attitudes as to the fairness and equity of the tax system and our administration thereof.
Because of their influential role and the unique position they have in influencing taxpayer behaviour, we recognise that they are one of the primary ingredients in our pursuit of our main corporate goal: “To ensure that everyone complies with their tax and customs responsibilities”.
We therefore spend a lot of time engaging with them using a combination of methods and through many different forums in our efforts to achieve improved taxpayer compliance.

WHAT CAN BE TAX STRATEGY ?

Our strategy in relation to dealing with tax professionals can be laid out in our recent Operational Strategic Programme 2007-2010. Because of the fact that the phrase “tax professional” encompasses persons with a variety of roles and responsibilities, the tax administration must prepare a response to ensure that strategy works.
I would like to give you some background on how the building relationships and partnerships strategy will come about. The relationship between taxpayers and tax administration, I must confirm that is very much an adversarial one characterised by mutual distrust and suspicion. Tax administration recognises that albanian tax professionals have a key role and that is why we have developed sophisticated consultative mechanisms to help administration engage with this wide community.
Let me give you some relevant facts about the Albanian tax system.

ALBANIA’s TAX SYSTEM

Our tax system is concerned with direct and indirect taxes, customs and duties. Albania has taxes on incomes, as well as taxes on goods and services.
Businesses (limited companies and individuals) pay tax on a self-assessment basis. There are approximately 49,000 self employed individuals and 13,000 limited companies on our register.
The General Taxation Directorate is the sole central tax authority in the Republic of Albania. The General Directorate of Taxes (HQ) and its Branch Offices in the districts possess authority to implement and administer taxes. The General Directorate of Taxes is located in Tirana. The General Taxation Directorate establishes its Local Tax Offices in 36 districts and since 1998 is established in Tirana the Large Taxpayer Office. Local Tax Office Heads are appointed and discharged by the General Director of Taxes. The Local Tax Offices provide taxpayers with tax certificates, prepare draft program of tax revenues for the district, supervise and are accountable for accomplishment of the tax revenues and the program, process tax declarations, assess tax liabilities, preserve and organise documents, audit taxpayers and collect taxes as well as implement special executive decisions.
General Taxation Directorate has recently undergone a major organisational restructuring. Essentially, this agency has rebuilt the organisation around different groups of taxpayers. These groups consist of taxpayers in each of four geographic regions and a national large taxpayer group. Apart from collection and debt management functions which remain centralised every other small taxpayer is managed from 2007 from tax offices of local power, as effect of fiscal decentralization in Albania.

WHO AND WHAT ARE ALBANIAN TAX PROFESSIONALS ?

In aLBANIA, a wide range of tax professionals such as accountants, lawyers, tax consultants, businesses and freight forwarders acting on behalf of their clients, the taxpayers, interacting with tax offices. These tax professionals perform a wide variety of functions.
The variety of professionals providing a great deal of tax advice or engaging in compliance activities is generated on the activities of such professionals. For example, accountants, advising on business transactions and internal audit; lawyers such as solicitors and barristers advising on business transactions, conveyancing, estate administration and litigation; auctioneers and real estate agents advising on capital transactions, and customs agents advising on customs matters. Each of these activities in its own right involves some form of tax advice and each professional can be regarded as a “tax professional”, each of which, play a very important part in ensuring that our tax administration and systems work.
Traditionally most VAT businesses and a little number of self-employed persons, i.e., businesses, professions, companies and their directors, use the accountant as tax professional, or “agent”, to engage with tax officials. This high level of representation, even for small business, is because we don’t operate an imputed income system. All businesses have to prepare business accounts on an “accruals” basis, and this generally requires the services of an accountant.
In Ireland we refer to our mainstream tax professionals as “tax practitioners” or “agents” and there are approximately 2,000 such “agents” registered in tax offices when they act as tax return preparers. As a result of this high level of agent representation, taxpayers in Albania tend not to be inhibited about challenging tax administration, and engage in more sophisticated business transactions and use tax professionals to this end.
Another reason for taxpayer challenges is the recent phenomenon of taxation departments being created in legal firms. Also, many corporations are employing lawyers who specialise in mainstream taxation matters and now lawyers are not just engaged in the traditional legal bastions of capital taxation and inheritance tax matters. Primarily, as a result of our Tax Investigation Department a dedicated part of tax administration which pursues the proceeds of crime, our barrister profession, who traditionally did not advocate in taxation matters, are now representing more and more taxpayers in tax matters in the civil and criminal courts.
This increasing competition from the legal profession has raised some issues as regards a level playing field between the different professions. Accountants see the prospect that lawyers might be able to claim legal professional privilege on behalf of clients against Revenue enquiries in certain circumstances as an unfair competitive advantage.

INFLUENCING COMPLIANCE BEHAVIOUR

One of the obvious benefits for tax administration from the engagements with tax professionals is the extent to which they can get them to influence good compliance behaviour. As already mentioned, tax offices regard tax professionals as being hugely influential in terms of promoting good compliance behaviour; indeed, because they may be the only point of contact that a taxpayer has in his/her interactions with tax administration.
However, it is important that tax professionals also see it as in their interest to do so. Not alone does ‘non-compliance’ cost money in lost taxes for tax administration, but it also puts the taxpayer, the client, at serious risk of severe consequences if caught. Being able to deal with taxpayers through their agents substantially reduces the cost of tax administration. Think of what life would be like for a tax administration if there were no tax professionals. Some people who work for tax administrations might say that life would be much easier without them. Yes, there might not be so much tax planning, or challenges to taxation, and taxpayers might be more willing to accept tax administration’s view. This might make life easier for the tax officials. But given the complexity of tax system for enyone that it’s no part of tax administration, despite all the efforts at simplification, think of what the disadvantages might be?
Instead of funnelling the interaction with businesses and corporations through 2,000 tax professionals, it would be necessary to interact directly with an additional 49,000 business and over 13,000 corporate taxpayers. This would have huge cost implications for tax administration, as more employees would be needed to service the substantial additional contacts and queries that would ensue.
It would also be immeasurably harder for tax administration to ensure that all taxpayers understood their obligations and this would adversely affect voluntary compliance.
For these reasons, tax structures try to make it as easy as possible for tax professionals to meet their client’s compliance obligations and we provide a variety of support services and measures to support and achieving client’s compliance.

SUPPORT AND SERVICE FOR TAX PROFESSIONALS

Tax professionals have a big interest in customer service efforts and are rightly critical when the tax services falls below standard. After all, the tax professional is in business to make a profit. Poor service on the tax offices costs money and the taxpayer does not always understand either.
Here are some examples of how tax administration can support and try to try to make life as easy as possible for tax professionals.

Simpler Organisational Structure
In the albanian tax structure, all taxes pertaining to a taxpayer are handled by one office. Prior to that, a taxpayer (or tax professional) could have to deal with a number of offices depending on the tax.
This tax structure makes it much easier for the tax professional to deal with their client’s compliance obligations. However there are problems following the reallocation of all our taxpayer cases in the restructuring period. For some time, tax professionals are unsure which office dealt with their clients. As a result of good contacts with the various professional bodies and in a spirit of openness and co-operation, which is part of taxation strategy of building partnerships, is the possibility for tax officials to engage proactively and positively with a view to implementing practical measures to remedy difficulties.

Some of these initiatives help illustrate this:

o Contact Points
There are special contact points in each of the regions for tax professionals who are experiencing service difficulties in dealing with tax administration. These contact persons are empowered to sort out the difficulty.

o Contact Locator
There is a tool known as ‘Contact Locator’ ,that in albania is not a function used, but in EU countries he can be used to find out which office deals with a taxpayer.

Information Tools
Tax strategy is to ensure clear and timely communication. Some of the many information tools are ready for providing up to date informatio:

– Tax official website http://www.tatime.gov.al

– Tax Buletin

– Tax leaflets

– Seminars and workshops

o Technology
By exploiting technology opportunities as much as possible such as electronic e-filing service, tax structures are able to provide better service while at the same time reducing compliance and their administrative costs. This makes it easier and cheaper for tax professionals to file and pay.

o Fair procedure
Through mechanisms such as tax procedures and Tax Audit Practice Guidelines and other papers and circulars that help the conduct of tax strutures in confront of taxpayers and tax proffesionals.

CONSULTATION

While, everyone recognises that albanian tax administration has responsibility for the tax system and makes the final decisions, we know that we can do things more effectively, if there is a spirit of cooperation and mutual understanding with tax professionals.
Both tax structures and tax professionals have a mutual self-interest in bringing common sense and clarity to what is a complex area of business and personal life of taxpayers. The consultation is very important – our strategy is that we listen, we exchange views and ideas, and we generate ideas. On the other hand it is important to get the professional’s practical business perspectives and learn from their experiences. Sometimes a more informative practical viewpoint, e.g. learning practical insights and difficulties in operating legislation, is a more valuable insight than discussions about proposals or the difficulties in implementation of current legislation in an internal vacuum.

BENEFITS TO TAX ADMINISTRATION

As well as the invaluable role, played by practitioners in promoting and fostering a pro-compliance culture in Albania, they have also been a significant catalyst and facilitator of some of the major changes in tax administration here.
Tax administration has make changes to keep pace with one of the fastest growing economies in the mediterranean region over the last 5 years which has brought enormous challenges for us on many fronts, but particularly in terms of:

– Growing number of taxpayers
– Taxpayers with increasingly complex and financial and investment profiles

All of the changes have occurred while resources have remained static. With the support (and sometimes the forbearance) of tax professionals, tax administration has managed to transform itself from an organisation that was focused on process and procedure, structurally frozen, averse to change and largely indifferent to its customers’ needs to one which is trying now to customer focused, more effective in its core businesses, structurally flexible, risk driven and looking forward with enthusiasm to the challenges ahead.
I would like to illustrate this by mentioning just a few of these major changes and the role of tax professionals in facilitating them:
The near future tax declaration-on-line filing service in Albania, it’s aspected to be a phenomenal success. In industrialised countries of EU, even though e-filing is not mandatory, over 53% of self employed taxpayers filed on-line last year, in order to be increased to over 60%. This is because so many of the returns are filed by tax professionals who have been active partners in our e-filing success. As a result, there have been huge benefits for both Revenue and practitioners in terms of service and cost. Tax professionals have been the most enthusiastic supporters of our on-line filing system and we are continuing to work closely with them in developing it to ensure that it continues to meet their needs and concerns re service, security and confidentiality.

CHALLENGES AHEAD

There are some serious challenges ahead for the Tax Administration -Tax Professional relationship. Some of the main ones are that come to mind are:

Tax Planning and Avoidance
It would be wrong to give the impression that tax structures accept everything that the tax professional engages in. One of the main areas of contention is ‘avoidance’ or aggressive tax planning. While professionals have a key role to play in relation to promoting compliance, there are problems sometimes when tax planning steps over the line. Of course tax offices understands the motive for tax planning. Naturally, all taxpayers want to pay less tax and if there are ways of avoiding tax, and some are willing to pay a lot of money for it. The problem is when such schemes have the potential to undermine the integrity and legitimacy of the tax system in the wider community.
There is an ongoing debate with tax professionals as to where that line is – what’s acceptable and what’s unacceptable. The tax administration’s objective is to move tax professionals and their clients away from getting involved in unacceptable tax planning schemes. On the other hand, albanian tax administration are closely monitoring new developments in other countries to establish the best approach to take to change behaviour in this regard.

Integrated Revenue view of Taxpayer and Risk
The tax administration approach to tackling risk, in tax structures, is to analyse risks for a taxpayer across all taxes. This makes it more difficult for the general tax professional who may act in relation to some of the taxes only. It may present particular problems when preparing for a revenue audit when the full range of taxes and duties, from income tax to excise duties, could be reviewed.

More Professional Regulation
It’s not just tax administration that tax professionals have to deal with. They have to contend with more and more statutory reporting requirements from other bodies such as the Prosecutor, money laundering department, Customs, and many other public agencies regarding company law offences, to illustrate just a few regulatory bodies. The whole compliance environment is becoming more difficult for the practitioner and this is not being made easier by duplication of requirements from the various public bodies. However, we are working with other agencies to try and streamline matters where possible.

Finishing off Legacy Business
In the last four years, tax investigation units have carried out a number of large investigation projects aimed at dealing with tax evaded on funds hidden by way of various means, such as money laundering in the registered businesses, under reporting or missing declarations of incomes etc .
As mentioned earlier, there is a new investigation scheme underway into undeclared funds hidden. Because of the numbers of taxpayers involved, approximately 1, 000 over the last 2 years, tax professionals are complaining about the strain that all this extra work is placing on them which is in addition to their normal advisory and returns preparation work. The timing and management of some of these special investigations has been a bone of contention with them and this has caused some difficulties in their relationship with tax administration.

CONCLUSION

Tax professionals sometimes ask hard questions which tax officials may not have asked themselves and, which tax administration has to answer. This ultimately is of benefit to tax administration as it focuses them on dealing with and addressing difficult issues, which may have been overlooked.
As key stakeholders they want tax professionals to have a sense of ownership in the tax system. This partnership approach with them also helps to counter relationships of distrust and enables tax administration to create real relationships. To this end, the good relationship with tax professionals can help in building public confidence in the tax administration. In terms of our objectives, we have benefited from our approach with them. However, tax officials should not get carried away. While they have a long engagement, the marriage has been more one of convenience than of love for each other. Paying tax will never be popular and there will no doubt be serious difficulties ahead. This relationship overall is on a sound footing and capable of withstanding whatever troubles lie ahead. In this conclusion I can pronounce the sentence that I’m carrying in my mind always “Tax administration need tax professionals and they need tax administration”.

Small Business Tax Tip – Corporation, LLC, Partnership or Proprietorship?

Sometimes it’s the small decisions — or lack of a decision — that have the greatest effect on your business.

Take the choice of what type of legal structure you use to operate your business. Many small business owners are so excited about starting their businesses that they give little or no thought to this very important decision. Should you incorporate? Form an LLC? A partnership? Would you be better off just doing nothing and running your business as a sole proprietorship?

Before you take the advice of the first person you ask or the first book you read, consider all of the legal, tax, financial and operational effects of your choice. Let’s look at your choices one by one.

Sole Proprietorship

When you open your business without a partner (a spouse does not usually count as a partner for this purpose) and without filing any paperwork to choose one of the other business types, you are automatically a sole proprietorship. You are doing business with your customers directly as yourself, an individual. This is true even if you have a name for your business and file “fictitious name” or “doing business as” papers with your state or local government.

For income tax purposes, there are no separate forms to file for the business. You simply attach Schedule C to your Form 1040. Schedule C is where you summarize your business revenues and expenses. You pay tax on any profit at the regular individual tax rates. If you have a loss, you can usually deduct the loss against your other income.

In addition to income tax, you must pay self employment tax on your business profit. The self employment tax rate is 15.3% on the first $94,200 (for 2006) of profit, and 2.9% on any amount over $94,200. The tax is designed to replace the social security and medicare taxes you and your employer pay when you have a regular job. Since you’re both “employer” and “employee,” you pay twice as much as you would if you worked for someone else.

The biggest pitfall of being a sole proprietor is your legal liability. If someone is injured, whether physically, financially, emotionally, etc. as a result of your business activities, you can be sued personally. In today’s litigious environment where people are sued at the drop of a hat, this is a risk no serious business owner should take lightly. While insurance may offer some protection, you still run the risk of losing your personal assets, and/or of having to file bankruptcy, due to a lawsuit.

While this form of business may be fine for some part-time or “sideline” businesses, most small business owners should choose a different option.

Partnership

When you co-own a business with one or more other people and don’t choose one of the other business types, you are automatically a partnership. (Technically, a “general partnership.”) While a sole proprietorship is low on the list of desirable business structures for a small business, a partnership is even lower.

Like a sole proprietorship, you can be sued personally for any harm you cause as a result of your business activities. Even worse, you can be sued for any harm caused by your partner! Not only that, if your partner signs a contract or takes out a loan on behalf of the business, you are automatically bound by the terms of that contract, whether you agree with it or not. This is scary stuff, and I simply never recommend this structure. This is an example where “doing nothing” can be a big mistake.

Income tax wise, a partnership must file a Form 1065, U.S. Return of Partnership Income, to report its revenues and expenses. The partnership itself does not pay income taxes. Rather, each partner reports his share of the profit or loss from the business on his individual tax return. As with a sole proprietorship, an active partner must pay the 15.3% self employment tax on his first $94,200 (for 2006) of the partnership income, and 2.9% on any amount above that.

There is a different kind of partnership, called a Limited Partnership, that restricts the liability of certain “passive” partners, called limited partners. This is used primarily in real estate syndications and is outside the scope of this article.

The bottom line on partnerships: Stay away from them.

Corporation

A corporation is a separate legal entity, or legal “person” if you will, formed by filing certain documents with a state government. Most big companies you’re familiar with are corporations, and will usually have the word “corporation” or “Inc.” in their business name. Corporations have several advantages, including the ability to raise money by selling stock, and the fact that each owner’s, or stockholder’s, risk is limited to their investment in the company. A corporation can have one owner, or millions of owners, or any number in between.

As mentioned above, your risk in case of a lawsuit is generally limited to the amount of money you have invested in the corporation. There are important exceptions to this general rule, a few of which are worth mentioning. First, if you are in one of the classic professions, usually including doctors, lawyers, accountants, and engineers among others, you cannot escape personal liability for your professional activities. In other words, if you’re a doctor and you amputate the wrong leg on a patient, you can still be sued personally. On the other hand, if a patient trips over a chair in your waiting room and breaks their leg, the normal corporate protection would apply.

A second exception has to do with how you operate your business, and how you present yourself to the outside world. When you form and run a corporation, you are obligated to make sure everyone you deal with knows they’re dealing with a corporation. So, for example, you would want to make sure you included your full corporate name on all letterhead, business cards, advertising etc. You don’t want anyone to be able to say they thought they were dealing with you as an individual and not your corporation.

Another liability exception has to do with recordkeeping. This is where many small business owners get themselves in trouble. A corporation must maintain books and records separate from that of its owners. Also, by definition a corporation issues stock and has a board of directors. That board of directors must have a meeting at least once per year, and formal minutes must be kept. Any significant activities of the corporation, such as taking out a loan, usually require approval by the board. Now the reality is that in a small business you may be the owner and only member of the board of directors. But you still have to keep up the formalities required by your state, and the state where you incorporated (if different). If you don’t, a good attorney might argue that you should be able to be sued personally, thereby “piercing the corporate veil” and leaving your personal assets exposed. An IRS agent can make the same claim, thereby disallowing certain deductions and tax benefits you receive by operating as a corporation. So consult a competent attorney, and make sure your corporate books and records meet the legal requirements.

For state law purposes, a corporation is a corporation. But for tax purposes, a corporation can be either a regular “C corporation” or receive special tax status by being an “S corporation.”

C Corporation

Unless a corporation qualifies for and chooses to be an S corporation, it is automatically classified as a C corporation. A C corporation pays taxes on its profits, and files a Form 1120 with the IRS. Any excess profit is then distributed to the corporation’s owners, or stockholders. These profit distributions are called dividends, and the stockholders must pay income taxes on them. This is why it is said that a C corporation results in “double taxation.” Notice that the corporation’s profits are taxed twice: Once at the corporate level, and again when distributed to the owners.

Due to this double taxation, most small businesses are not well served by being a C corporation. That said, there are very limited circumstances where a C corporation can be used by a small business owner in order to gain certain tax advantages. Check with your tax advisor.

S Corporation

Subchapter S of the Internal Revenue Code was created and reworked by Congress late in in the 20th Century in order to allow small business owners to incorporate without being subject to double taxation. Thus, the “S corporation” was born, and has been the preferred tax structure for small businesses ever since (but see the section on LLCs below).

With an S corporation, the corporation files a Form 1120S with the IRS, but the corporation does not pay income tax (with a few rare exceptions). Rather, each owner pays tax on her share of the corporation’s profits, much like a partner in a partnership. The difference here of course, is that since it is a corporation under state law, there are none of the legal liability problems associated with partnerships. And since the corporation does not pay income tax, there is no double taxation as there is with a C corporation. In effect, it allows a corporation to be taxed like a partnership.

Unlike a partnership, if handled properly, you do not pay self employment taxes on the profits of the S corporation. Instead, you are paid a salary, and the applicable social security, medicare and other payroll taxes are paid accordingly. Any dividends in excess of your salary are not subject to payroll or self employment taxes. So if you have a low salary and high dividends, you save 15.3% in taxes on the dividend portion. Of course the IRS knows this, and they require you to pay yourself a “reasonable” salary. How much salary you should pay yourself vs. dividend distributions is a much debated topic between taxpayers and the IRS, and also offers many opportunities for tax planning.

Not every corporation is qualified to be an S corporation, though most small businesses qualify. There are restrictions on such things as the number of stockholders and what type of entities can be stockholders. The basic purpose of the rules is to prevent large, publicly traded companies from qualifying, and to prevent various tax avoidance schemes using trusts and foreign entities.

A corporation must elect S status no later than the 15th day of the third month of the year in which it wishes to be treated as an S corporation. For example, for a calendar year business, a corporation must make the election by March 15, 2008 in order to be treated as an S corporation for 2008. You make the election by filing Form 2553, which must be approved by the IRS in order for it be effective.

Overall, the S corporation is an excellent structure for most small businesses.

Limited Liability Company (LLC)

The newest of the business structures is the limited liability company or LLC. The LLC affords much the same protection against lawsuits as the corporation, without most of the somewhat burdensome paperwork and recordkeeping requirements, such as stock certificates, board of directors meetings, board minutes, etc. In addition, the LLC is very flexible from a tax standpoint, allowing you the choice to be taxed as either a C corporation, an S corporation, a sole proprietorship (for businesses with one owner) or a partnership (two or more owners).

Each state has its own rules for who can form an LLC, but most states now allow an LLC to have just one owner (that wasn’t always the case). Most small businesses will qualify. Forming an LLC is usually quite simple and relatively inexpensive, and can often be done right over the internet.

For tax purposes, an LLC with one owner will be taxed as a sole proprietorship, unless the owner makes an election to be taxed as a corporation (C or S). An LLC with multiple owners will automatically be taxed as a partnership, unless the LLC chooses to be taxed as a corporation (C or S). Do you see the beauty of this structure? You get liability protection akin to a corporation, but you don’t have all the nit picky paperwork to do and the “corporate book” to maintain. At the same time, you get to choose how you’re treated for tax purposes! That’s enough to make a tax accountant’s heart flutter!

As you can probably tell, I really like the LLC structure. My own business, Thomas Norton & Company, LLC, is obviously structured this way. I have also elected to be taxed as an S corporation, since it gives me certain advantages in my circumstances. It should be noted that you can start an LLC and be taxed as a sole proprietorship at first, and elect to be treated as an S corporation at some future date.

Though the S corporation still rules the roost among small businesses, the LLC is fast making inroads as more and more business owners discover its simplicity, flexibility and effectiveness.

Which Structure is Best for You?

Since your circumstances might be different, you should consult a qualified tax advisor before making this important decision. That said, most small businesses are and should be structured as either an S corporation or an LLC. Whether your LLC should be taxed as a sole proprietorship, partnership, C corporation or S corporation is very situation dependent, so ask that tax advisor what he or she thinks.

No matter what form of business you choose, make sure it is a conscious choice, made after carefully considering the legal and tax ramifications involved. While it may seem mundane, it is one of the most important business choices you will ever make.

Selling Your Business – Deal Structure and Taxes

The purpose of this article is to demonstrate the importance of the tax impact in the sale of your business. As an M&A intermediary and member of the IBBA, International Business Brokers Association, we recognize our responsibility to recommend that our clients use attorneys and tax accountants for independent advice on transactions.

As a general rule, buyers of businesses have already completed several transactions. They have a process and are surrounded by a team of experienced mergers and acquisitions professionals. Sellers on the other hand, sell a business only one time. Their “team” consists of their outside counsel who does general business law and their accountant who does their books and tax filings. It is important to note that the seller’s team may have little or no experience in a business sale transaction.

Another general rule is that a deal structure that favors a buyer from the tax perspective normally is detrimental to the seller’s tax situation and vice versa. For example, in allocating the purchase price in an asset sale, the buyer wants the fastest write-off possible. From a tax standpoint he would want to allocate as much of the transaction value to a consulting contract for the seller and equipment with a short depreciation period.

A consulting contract is taxed to the seller as earned income, generally the highest possible tax rate. The difference between the depreciated tax basis of equipment and the amount of the purchase price allocated is taxed to the seller at the seller’s ordinary income tax rate. This is generally the second highest tax rate (no FICA due on this vs. earned income). The seller would prefer to have more of the purchase price allocated to goodwill, personal goodwill, and going concern value.

The seller would be taxed at the more favorable individual capital gains rates for gains in these categories. An individual that was in the 40% income tax bracket would pay capital gains at a 20% rate. Note: an asset sale of a business will normally put a seller into the highest income tax bracket.

The buyer’s write-off period for goodwill, personal goodwill, and going concern value is fifteen years. This is far less desirable than the one or two years of expense “write-off” for a consulting agreement.

Another very important issue for tax purposes is whether the sale is a stock sale or an asset sale. Buyers generally prefer asset sales and sellers generally prefer stock sales. In an asset sale the buyer gets to take a step-up in basis for machinery and equipment. Let’s say that the seller’s depreciated value for the machinery and equipment were $600,000. FMV and purchase price allocation were $1.25 million.

Under a stock sale the buyer inherits the historical depreciation structure for write-off. In an asset sale the buyer establishes the $1.25 million (stepped up value) as his basis for depreciation and gets the advantage of bigger write-offs for tax purposes.

The seller prefers a stock sale because the entire gain is taxed at the more favorable long-term capital gains rate. For an asset sale a portion of the gains will be taxed at the less favorable income tax rates. In the example above, the seller’s tax liability for the machinery and equipment gain in an asset sale would be 40% of the $625,000 gain or $250,000. In a stock sale the tax liability for the same gain associated with the machinery and equipment is 20% of $625,000, or $125,000.

The form of the seller’s organization, for example C Corp, S Corp, or LLC are important to consider in a business sale. In a C Corp vs. an S Corp and LLC, the gains are subject to double taxation. In a C Corp sale the gain from the sale of assets is taxed at the corporate income tax rate. The remaining proceeds are distributed to the shareholders and the difference between the liquidation proceeds and the stockholder stock basis are taxed at the individual’s long-term capital gains rate.

The gains have been taxed twice reducing the individual’s after-tax proceeds. An S Corp or LLC sale results in gains being taxed only once using the tax profile of the individual stockholder.

Selling your business – tax consideration checklist:

1. Get good tax and legal counsel when you establish the initial form of your business – C Corp, S Corp, or LLC etc.

2. If you establish a C Corp, retain ownership of all appreciating assets outside of the corporation (land and buildings, patents, trademarks, franchise rights). Note: in a C Corp sale, there are no long-term capital gains tax rates only income tax rates. Long-term capital gains can only offset long-term capital losses. Personal assets sales can have favorable long-term capital gains treatment and you avoid double taxation for these assets with big gains.

3. Look first at the economics of the sales transaction and secondly at the tax structure.

4. Make sure your professional support team has deal making experience.

5. Before you take your business to the market, work with your professionals to understand your tax characteristics and how various deal structures will impact the after-tax sale proceeds

6. Before you complete your sales transaction work with a financial planning or tax planning professional to determine if there are strategies you can employ to defer or eliminate the payment of taxes.

7. Recognize that as a general rule your desire to “cash out” and receive all proceeds from your sale immediately will increase your tax liability.

8. Get your professionals involved early and keep them involved in analyzing various bids to determine your best offer.

Again, the purpose of this article was not to offer you tax advice (which I am not qualified to do). It was to alert you to the huge potential impact that the deal structure and taxes can have on the economics of your sales transaction and the importance of involving the right legal and tax professionals.