A Newsletter of Rothstein Kass® Third Quarter 2008
Inside: Tax Considerations In Selling
Questions and Answers
3
Your Business
Finding Tax Shelter in
Estate Planning
4 So, you have decided that now is the right in a tax-free stock sale (type B reorganization), an
time to sell your business. It wasn’t an easy acquirer corporation acquires control of a target via
Facts That Figure decision as a lot of your “blood, sweat, and acquisition of at least 80% of the voting shares and
4
tears” went into getting the business to where other shares. The only permissible consideration to be
it is today. You have done your homework received from the acquirer either is its voting stock or
from an economic perspective including the voting stock of a corporation that controls it.
addressing employee retention matters, the
The benchmark of tax-free reorganizations is one
right valuation range, and identification of
of deferral. The tax basis of the assets or stock
prospective suitors, but have you thought
relinquished becomes the basis of the property
through the tax aspects?
received (i.e., carryover basis). There is also a
Tax considerations are an important ingredient in tack-on of the holding period. Accordingly, the
the mix that must not be overlooked. Professional deferred gain would be realized upon the subse-
tax planning strategies are essential to reduce quent disposition of the property received in the
the tax bite from your hard earned pay day. reorganization, but only to the extent of the gain
Transactional form and business structure drives realized upon the subsequent sale.
the ensuing tax consequences. The balance of this
Reorganizations are subject to the continuity of inter-
article will present a brief overview of the general
est doctrine. significant amounts of boot, or money
tax principles to observe, pitfalls to avoid, and
received as part of the deal, can be received in a type A
planning opportunities to take advantage of
reorganization in addition to the stock of the acquirer.
when selling your business.
TAx-FRee ReoRgANizATioNs AsseT vs. sToCK DeAl
if you want to walk away with the money instead,
if you are willing not to cash out immediately, you
you must also pay the tax piper. But, you obviously
can defer gain on the sale by accepting stock
want to reduce the tax bill to the extent reasonably
of the purchaser. A corporation, including an s
possible. The best of all worlds would be a single-
corporation, can dispose of its assets tax-free via a
level capital gain taxed currently at a 15% rate for
type A or type C reorganization. A stock-for-stock
federal tax purposes plus state tax considerations.
tax-free transaction can be effectuated via a type B
You can achieve this result by selling the stock in
reorganization. A type A reorganization is a statutory
your corporation (either a C or s corporation).
merger of two or more corporations whereby the
target merges into the acquirer and ceases to exist. Alas, the real world counters with the tension
Target shareholders exchange their stock for stock between seller and buyer desires. in today’s world,
or other interests in the acquirer. most buyers will insist on an asset deal. in addition
to legal liability considerations, the buyer wants
in a type C reorganization, the acquirer must acquire
to acquire assets that will generate valuable tax
at least 80% of the target’s assets at fair value in
write-offs for them. in a C corporation structure,
exchange solely for its voting stock. Any other
an asset deal will result in two levels of tax; one at
consideration can be used to acquire the balance
the corporate level on the sale of the assets and a
of the assets. The target must then distribute
second tax at the individual level upon distributions
such stock and other consideration received to its
in liquidation of the C corporation. The effective tax
shareholders in exchange for their stock. The target
rate for a New York City resident and a New York
then must liquidate.
City business under this scenario approaches 60%.
(continued on page 2)
Tax Considerations In Selling Your Business
(continued from page 1)
An asset sale in a s corporation setting still can A sale of a partnership interest produce similar
generate only one level of tax for federal tax results to that of a sale of assets by the partnership
purposes. The exception being if the s corporation in terms of ordinary income classification. When
is subject to the built-in-gains tax. such could apply a partnership interest is sold, gain attributable to
if the corporation had converted to s status from the sale of “hot” assets is reclassified as ordinary
C status within a 10-year tax period preceding income. Hot assets includes inventory and unrealized
the asset sale. Also, states could impose an entity receivables. The latter term includes depreciation
level tax on the s corporation (which is becoming recapture and contracts that will generate ordinary
the exception as compared to the rule) or s status income. This feature is a distinct disadvantage for
could be ignored as in the case of New York City. selecting partnership format over s corporation
status as there is no parallel concept when one sells
However, even with one level of tax, the gain will
its stock in a s corporation.
be converted to ordinary income as compared to
capital gains as pertaining to the sale of specific A partnership of which at least 50% of its interests
assets. ordinary income type assets include inven- are sold within a 12-month period experiences
tory, accounts receivable for a cash basis taxpayer a constructive termination. There is a deemed
and fixed assets subject to sec. 1245 depreciation liquidating distribution of its assets to the partners
recapture rules. followed by a deemed contribution of the same
assets to a new partnership.
gain on tangible property used in the trade of a
business, such as machinery, held for more than one A sole proprietorship is not regarded as a distinct
year will be considered as capital gains but recaptured legal entity separate from its owner. Therefore,
as ordinary income to the extent of accumulated a sole proprietor necessarily would be viewed as
depreciation. selling the business assets. A pre-sale, tax-free
incorporation should be afforded consideration.
goodwill and other intangible property, such as
However, one must be careful not to run afoul of the
customer lists, are considered as capital assets. The
step transaction doctrine whereby the iRs could
buyer would generally be able to amortize the allo-
deny tax-free treatment on the initial transfer of
cated price to intangible assets over 15 years for tax
appreciated assets to the new corporation.
purposes. Any allocated value to a covenant not to
compete will generate ordinary income to the seller. iNsTAllmeNT sAles
A corporation that acquires 80% or more of the Typically, all sale proceeds will not be received in the
stock of an s corporation within a 12-month period year of the sale. When at least one payment with
may elect, instead, to treat the transaction as a respect to the purchase price is to be received after
qualified asset purchase for tax purposes, and the the close of the tax year in which the sale occurred,
seller must consent to the election. This is referred the seller will report gain pursuant to the installment
to as a sec. 338 (h) (10) election. The buyer could method of reporting, unless he/she elects out.
agree to compensate the seller in terms of increasing
the consideration for any additional tax costs to overall gross profit percentage is determined for
the seller resulting from the deemed asset sale. the sale by reference to the contract price and
the tax basis of the assets sold. The seller then
in an asset acquisition, valuation of the specific applies this percentage to the payments received
assets is critical and becomes a point of negotiations each year so as to derive the reportable gain for
between the parties, and buyer and seller must the year.
ultimately conform to consistent treatment.
(independent appraisals of asset values may be The installment note should bear interest. install-
appropriate under the circumstances.) generally ment reporting does not apply to the sale of certain
speaking, the iRs would respect contract allocations assets, such as publicly traded securities and
as negotiated by unrelated parties with adverse inventory. Also, depreciation recapture is recognized
interests. And generally, the sellers’ proceeds are in the year of sale.
increased by the amount of liabilities assumed by generally, a corporation does not recognize gain
the buyer for purposes of determining gain on or loss upon the distribution of an installment
the sale of assets. obligation to its shareholders in liquidation.
S corporation shareholders would reflect their Rather, the shareholders step into the shoes of
distributive share of income/loss for the short the distributing corporation and report the gain
period prior to sale of their stock. The shareholders on the installment method. Nondealers must pay
also take these amounts into consideration for an interest charge on the deferred gain when
purposes of calculating stock basis. A pro-rata they hold installment obligations with a face
portion of the s corporation’s items of income/loss value in excess of $5 million.
is allocated to the selling shareholder unless an (continued on page 3)
election is made to close the books at the date of
sale for allocation purposes.
2 Rothstein Kass | family BUSINESS | Third Quarter 2008
Tax Considerations In Selling Your Business
(continued from page 2)
exClusioN oF gAiN oN sAle oR planning for high-net-worth individuals. Paul’s
exCHANge oF smAll BusiNess sToCK business tax experience includes handling matters
for domestic-owned corporations, closely-held
Non-corporate taxpayers can exclude 50% of corporations, large s corporations, nonprofits,
the gain recognized from a sale or exchange of family offices, private equity funds and partnerships.
certain qualified small business stock (QsB stock).
The stock must be held by the taxpayer for more on the international side, Paul is involved with
than five years. The stock must be that of a C expatriate planning, entry/exit strategies, and related
corporation engaged in a qualified trade or compliance matters. in addition, he has developed
business. A qualified trade or business is generally and implemented inbound/outbound tax structures
one other than the performance of professional utilizing tax favored holding companies, blocker
services or hotels, restaurants and similar businesses. entities, and transparent entities, including check
The corporation’s aggregate gross assets cannot the box elections. He is also knowledgeable of
exceed $50 million. other requirements do apply. and skilled in CFC, PFiC, transfer pricing, earnings
However, alternative minimum tax (AmT) consid- stripping, foreign tax credits, treaties, and with-
erations can significantly curtail the benefits as holding. Paul has also been involved with reviewing
7% of the exclusion is taxable for AmT purposes. tax accruals from a FAsB 109 perspective and has
worked on numerous mergers/acquisitions from
Another benefit of QsB stock is the ability of both a consulting and implementation standpoint.
deferral by rolling over the gain from the sale of Furthermore, he frequently lectures before profes-
QsB to other QsB stock. The rollover is similar to sional groups on international tax issues.
the sec. 1031 like-kind exchange rules and must
be made within 60 days of sale. The basis of the Paul’s past professional experience includes serving
stock sold is carried over to the purchase of the as a managing director with Rsm mcgladrey, inc.
replacement QsB stock. and a tax partner at goldstein golub Kessler llP in
New York. He earned a master of Business Admin-
As can easily be seen, tax consequences attending istration and a Bachelor of Business Administration
a sale of your business can become quite complex. in Accounting from Bernard m. Baruch College,
Competent tax professional advice is a must in City university of New York. Paul is a member
terms of navigating through the myriad oppor- of the New York state society of Certified Public
tunities and obstacles. Accountants (NYssCPA). over the years, he has
About The Author been actively involved with the NYssCPA having
Paul Dailey, CPA, Principal served as co-chair of the Foundation for Accounting
Paul is a tax principal based in the New York office education’s small Business Taxation Conference
of Rothstein Kass. As a member of the Firm’s and chair of the international Taxation Committee.
Commercial services group, he oversees international He is also a member of the American institute of
tax issues for corporate and individual clients. Certified Public Accountants (AiCPA).
Paul is a certified public accountant in New York. For more information, please contact Paul Dailey,
Paul specializes in tax planning, consulting and CPA, principal at 212.997.0500 ext. 3958 or via
compliance issues for large, foreign-owned e-mail at pdailey@rkco.com.
corporations as well as residency issues and tax
Questions and Answers:
Q: Can you swap vacation homes tax-free?
A. under a special tax law provision, you can exchange 2. For the two 12-month periods immediately
like-kind properties without paying any current tax. preceding the exchange, you rent the home
Both the relinquished property and the replacement at a “fair” rental price for 14 days or more;
property must be investment or business property. and keep your personal use below the greater
in a new ruling, the iRs says that a vacation home of 14 days or 10% of the number of days
constitutes investment property for this purpose that the home is rented at a fair rental price.
if it meets the following two-part test: However, the iRs may still deny tax-free
treatment if you show minimal effort to treat
1. You must have owned the property you are
either place as investment property.
giving up for at least 24 months before the
exchange and the new property for at least
24 months afterward.
Rothstein Kass | family BUSINESS | Third Quarter 2008 3
Finding Tax Shelter in Estate Planning
shield assets with a credit shelter trust family BUSINESS is
published by Rothstein
Who are the beneficiaries of your estate? William could leave half of his estate, or $2 million, Kass, Certified Public
Accountants, for the
For many entrepreneurs, it is typically a to susan outright and transfer the other half general information of
combination of a spouse and children. to a credit shelter trust. For instance, this can our clients, friends and
However, part of the net worth you intend to be accomplished by establishing the trust in his business associates and
pass to your loved ones could be eroded by will (i.e., a testamentary trust). There are two should not be acted upon
estate taxes. Fortunately, you may be able to common methods: without prior professional
shelter your estate from tax through a “credit consultation. If you have
• The will can provide that the income from any inquiries or would like
shelter trust” (also called a “bypass trust”).
the trust is to be distributed among the to have your name placed
Thanks to the unlimited marital deduction, any surviving spouse and children. on our mailing list, please
transfer of assets from one spouse to another contact our office.
• if there is concern about a surviving spouse’s
is completely exempt from federal estate tax. Managing Editors
financial security, trust income can be paid
Furthermore, for decedents dying in 2008, up
to the spouse for life. Richard J. Flynn, JD
to $2 million of assets can be effectively sheltered
David B. Kaufman, CPA
through the credit known as the estate tax exemp- going back to our example, the $2 million trans-
tion. This exemption amount increases to $3.5 ferred to the trust is sheltered by the estate tax Editorial Advisors
million for 2009. exemption for William’s estate. it bypasses susan’s evan Jehle, CPA
estate completely. And when susan dies, there is Alan s. Kufeld, CPA
under the economic growth and Tax Relief Recon-
no estate tax on the $2 million she leaves to the elizabeth Nam, JD
ciliation Act of 2001 (egTRRA), the federal estate
children. With the credit shelter trust, $4 million
tax is scheduled to be eliminated after 2009, but it JoAnn Ralph, CPCu, CiC, CRm
is transferred estate tax-free.
is then scheduled to be reinstated in 2011. By using Paul H. Rich, CPA, Cm&AA
a credit shelter trust, you may transfer a sizable of course, you must consider other factors— seymour g. siegel
amount to your heirs by combining the marital including the application of state inheritance mary Wilson, CPA, mBA, JD
deduction with the federal estate tax exemption. laws—as part of an overall estate plan.
Rothstein Kass Locations
Example: William marx, a successful business For more information, please contact Elizabeth Nam, Beverly Hills
person, owns assets currently valued at $4 million. JD, senior manager at 212.997.0500 ext. 3996 or via 310.273.2770
under his will, all of the property is to be trans- e-mail at enam@rkco.com. Dallas
ferred to susan, his spouse. Assuming that William 214.665.6000
dies in 2008, the assets pass to susan free of estate Denver
tax under the unlimited marital deduction. 303.675.0666
grand Cayman
But the exemption for William’s estate goes to 345.949.6333
waste. For instance, should susan die in 2009,
New York
the exemption for her estate can shelter $3.5 212.997.0500
million. The remaining $500,000 (adjusted for Roseland
investment performance) is subject to estate tax. 973.994.6666
san Francisco
415.788.6666
Walnut Creek
925.946.1300
www.rkco.com
Rothstein Kass is a registered trademark
Facts That Figure
of Rothstein, Kass & Company, P.C. and
its related affiliates, each of which is a
separate legal entity.
Beware of Municipal Bond Traps discounted municipal bonds are purchased in the
municipal bonds are often a favorite investment secondary market, the profit from a subsequent
for some. The main reason is that interest income sale is taxed as ordinary income to the extent of
A member of AgN international ltd,
generated by municipal bonds is exempt from federal the accrued discount. a worldwide association
income tax. Thus, for a taxpayer in the 35% tax of separate and independent
bracket, a municipal bond earning 5% is the effective Trust Advisory Fees accounting and consulting firms.
equivalent of a taxable bond yielding 7.69%. The u.s. supreme Court recently ruled that the
in order to comply with u.s. Treasury
2%-of-Agi (adjusted gross income) floor for
However, it is a misnomer to say that municipal Regulations governing tax practice
miscellaneous expenses applies to most investment (known as “Circular 230”), you are
bonds are completely tax-free. When interest rates
advisory fees paid by a trust. Now, in a follow-up hereby advised that any tax advice
decline, the value of a bond may increase. upon provided herein was not intended or
ruling, the iRs says it will not apply this decision
the sale of the bond, any profit is then taxable as written to be used, and cannot be used,
retroactively. Furthermore, for 2008 and later by any taxpayer for the purpose of (i)
capital gain. For example, if a bond with a face
years, it is expected to exempt a set percentage of avoiding u.s. federal, state or local tax
value of $10,000 is sold for $10,500, the $500 penalties, or (ii) promoting, marketing,
bundled fees from the 2% floor. This will make it or recommending to another party any
profit is taxed at capital gain rates. similarly, if
easier to allocate fees. transaction or matter addressed herein.