Asset Sales Versus Stock Sales: What You Need to Know

Selling a business is never a decision that should be made lightly. A business is something that you’ve likely worked hard to build from the ground up into the entity that you always hoped it could be—you don’t want to sell yourself short now that you’re moving onto bigger and better things. When it comes to selling a business, one of the most important decisions that you’ll have to make has to do with how the sale itself will be structured. In this situation, there are two main types that you have to decide between—an asset sale and a stock sale. What is the difference between these two options? Who benefits the most from each type of scenario? Thankfully, the answers are relatively straightforward.

What is an Asset Sale?
When selling a business as an asset sale, the important thing to understand is that the seller actually retains possession of the legal entity that represents the business. What the buyer is purchasing are the individual assets that the company holds. Those can include things like equipment and fixtures, but also extends all the way up to trade secrets, telephone numbers of customers and business contacts, inventory items and more.

An asset sale usually does not include any cash-based assets and the seller actually retains any long-term debt obligations that the business holds along with the legal entity of the business itself. However, normalized net working capital is also usually one of the assets that is handed over from seller to buyer in this type of a sale. This can include certain elements like accounts receivable, accounts payable, accrued expenses and more.

What is a Stock Sale?
With a stock sale, on the other hand, the buyer is really purchasing the shareholder’s stock of the seller directly. Even though the assets and liabilities that are transferred as a result of this type of sale tend to be very similar to an asset sale, the seller is also getting the legal entity or stake in the business at the exact same time. In a stock sale, any particular asset or liability that the buyer doesn’t expressly want will either be distributed (in the case of assets) or paid off entirely (in the case of liabilities) prior to the sale being completed.

An important difference between an asset sale and a stock sale is that in a stock sale, no separate conveyance of individual assets is required for the sale itself to be completed. This is largely due to the fact that the original title of each asset rests within the corporation, meaning that both are transferred from seller to buyer at the exact same time.

Who Benefits From Each Type of Sale?

Once you understand a little more about the differences between an asset sale and a stock sale, you must also understand which benefits in each type of situation. As is common with most business decisions, the different parties involved will usually favor one or the other depending on which side of the fence they fall on. Buyers tend to prefer asset sales, for example, as it affords them certain tax benefits that they won’t get from a stock sale. Sellers, on the other hand, tend to prefer stock sales because it often makes them less responsible for certain future liabilities that may present themselves like product liability claims, employee lawsuits and even benefit plans.

Perhaps the biggest reason why an asset sale is preferred from the point of view of the buyer is because the company’s depreciable basis regarding its assets is highly accelerated. An asset sale typically gives a higher value for assets that depreciate quickly. A particular piece of equipment that the business owns, for example, likely has a three- to seven-year shelf life. At the same time, lower values are given to certain assets that amortize much more slowly. Goodwill, for example, is generally considered to have a 15-year shelf life. This generates additional tax benefits on behalf of the buyer, doing a lot to reduce taxes as quickly as possible and thus improving the overall cash flow of the company during the first few years of its life. Buyers also tend to prefer asset sales because it’s much, much easier to avoid any potential liabilities like contract disputes or product warranty issues as a result.

This doesn’t mean that asset sales are universally easier for buyers, however. Certain types of assets are inherently hard to transfer due to certain issues like legal ownership and any third party consent that may be required. Intellectual property, for example, would likely require the seller to obtain some type of consent that can slow down the process of a sale dramatically.

One of the major reasons why sellers tend to prefer stock sales is because all of the proceeds they get from the sale are taxed at a much lower capital gains rate. When dealing with C-corporations, corporate level taxes are avoided entirely. Also, in a stock sale the seller is usually less responsible for any future liabilities – a products liability claim officially becomes the problem of the buyer at that point.

The Popularity of Asset Sales versus Stock Sales
According to research, approximately 30 percent of all business sales in the last few years were stock sales. It’s important to keep in mind, though, that this number varies wildly based on the size of the company that is being sold. Larger companies have a much higher chance of being stock sales than asset sales.

Regardless of whether you’re a buyer or a seller, it is always important to consult with your business partners, your legal representatives and your accounting professionals throughout all points of the process to help make sure that you’re making the most informed decision possible. The need to understand exactly what you’re buying, how you’re buying it and what it means for the future is of paramount importance, regardless of which party you belong to.

Not All Home Mortgage Interest Is Deductible

One of the current IRS audit initiatives is checking to see if taxpayers are deducting too much home equity debt interest. Generally, taxpayers are allowed to deduct the interest on up to $1 million of home acquisition debt (includes subsequent debt incurred to make improvements, but not repairs) and the interest on up to $100,000 of home equity debt. Equity debt is debt not incurred to acquire or improve the home. Taxpayers frequently exceed the equity debt limit and fail to adjust their interest deduction accordingly.

The best way to explain this interest deduction limitation is by example. Let’s assume you have never refinanced the original loan that was used to purchase your home, and the current principal balance of that acquisition debt is less than $1 million. However, you also have a line of credit on the home, and the debt on that line of credit is treated as equity debt. If the balance on that line of credit is $120,000, then you have exceeded the equity debt limitation and only 83.33% ($100,000/$120,000) of the equity line interest is deductible as home mortgage interest on Schedule A. The balance is not deductible unless you can trace the use of the excess debt to either investment or business use. If traceable to investments, the interest you pay on the amount traceable would be deductible as investment interest, which is also deducted on Schedule A but is limited to an amount equal to your net investment income (investment income less investment expenses). If the excess debt was used for business, you could deduct the interest on that excess debt on the appropriate business schedule.

Alternatively, the IRS allows you to elect to treat the equity line debt as “not secured” by the home, which would allow the interest on the entire equity debt to be traced to its use and deducted on the appropriate schedule if deductible. For instance, you borrow from the equity line for a down payment on a rental. If you make the “not secured” election, the interest on the amount borrowed for the rental down payment would be deductible on the Schedule E rental income and expense schedule and not subject to the home equity debt limitations.

However, one of the rules that allows home mortgage interest to be deductible is it must be secured by the home, and if the unsecured election is used, none of the interest can be traced back to the home itself. So, for example, if the equity line was used partly for the rental down payment and partially for personal reasons, the interest associated with the personal portion of the loan would not be deductible since you elected to treat it as not secured by your home.

Using the unsecured election can have unexpected results in the current year and in the future. You should use that election only after consulting with this office.

Generally, people not familiar with the sometimes complicated rules associated with home mortgage interest believe the interest shown on the Form 1098 issued by their lenders at the end of the year is fully deductible. In many cases when taxpayers have refinanced or have equity loans, that may be far from the truth and could result in an IRS inquiry and potential multi-year adjustments. In fact, for Forms 1098 issued after 2016 (thus effective for 2016 information), the IRS will be requiring lenders to include additional information, including the amount of the outstanding mortgage principal as of the beginning of the calendar year, the mortgage origination date and the address of the property securing the mortgage, which will provide the IRS with additional tools for audits.

When in doubt about how much interest you can deduct or if you have questions about how refinancing or taking on additional home mortgage debt will impact your taxes, please call this office for assistance.

2015 Transition Relief under the Employer Shared Responsibility Provisions

Under the Affordable Care Act, certain employers—referred to as applicable large employers (ALEs)—are subject to the employer shared responsibility provisions, which require ALEs to offer affordable minimum essential coverage healthcare coverage that provides minimum value to full-time employees and their dependents (but not their spouses). Failure to do so can result in the employer being liable for substantial penalties that the government refers to as shared responsibility payments.

Note: Whether an employer is subject to employer shared responsibility provisions is based upon the number of equivalent full-time employees (EFTEs) employed by the employer, generally in the prior year. However, the rules that determine who is a full-time employee are complicated. Generally, anyone who works at least 30 hours per week (or 130 hours in a calendar month) is considered a full-time employee. Part-time employees are those who are not full-time employees. All the hours worked by part-time employees for the month are combined and divided by 120, and this result is added to the number of full-time employees. This sum is the number of EFTEs for the month.

Example – Equivalent Full-Time Employees – For his business, John has 45 full-time employees and 20 part-time employees. In January 2016, his part-time employees worked 960 hours. That is the equivalent of 8 (960/120) full-time employees. Thus, John employed 53 (45 + 8) EFTEs in January. In this case, John’s business is subject to the employer shared responsibility provisions, but it is only required to offer coverage to full-time employees and their dependents.

The employer shared responsibility provisions were first effective on January 1, 2015, but transition relief from certain requirements is available for 2015, including the following:

  • ALEs with fewer than 100 EFTEs won’t be assessed an employer shared responsibility payment for 2015 provided that certain conditions were met regarding the employer’s maintenance of the workforce and preexisting health coverage. ALEs that are eligible for this relief must provide a certification of eligibility as part of the required information reporting for 2015.
  • ALEs were not required to offer coverage to full-time employees’ dependents for the 2015 plan year, provided that they meet certain conditions—including that they take steps to arrange for such coverage to begin in the 2016 plan year and that they do not drop current dependent coverage.
  • In general, if an ALE does not offer minimum essential coverage to at least 95 percent of its full-time employees and their dependents, it may owe an employer shared responsibility payment based on its total number of full-time employees. For 2015, 70 percent is substituted for 95 percent. However, even if an employer offers minimum essential coverage to at least 70 percent of its full-time employees and their dependents for 2015, it may still owe the separate—generally smaller in the aggregate—employer shared responsibility payment that applies for each full-time employee who receives the premium tax credit for purchasing coverage through the Health Insurance Marketplace.
  • If an ALE is subject to the employer shared responsibility payment because it doesn’t offer minimum essential coverage to its full-time employees and their dependents, the annual payment is generally $2,000 for each full-time employee—adjusted for inflation—after excluding the first 30 full-time employees from the calculation. For 2015, if ALEs subject to this employer shared responsibility payment have 100 or more EFTEs, their payments will be calculated by reducing the number of full-time employees by 80 rather than 30.
  • Transition relief is available for certain employers that sponsor non-calendar-year plans for the months in 2015 prior to the beginning of the 2015 plan year, if the employer and the plan meet various conditions.
  • Rather than being required to measure their ALE status based on the number of EFTEs for all twelve months of 2014, employers may instead base their 2015 ALE status on any consecutive six-month period from 2014 – as chosen by the employers.

For an employer with a non-calendar-year plan, the first four types of transition relief listed above also apply for the months in 2016 that are part of the 2015 plan year.

If you have questions related to your company’s employer shared responsibility, please give this office a call.

Household Help – Employee or Contractor?

Frequently taxpayers will hire an individual or firm to provide services at the taxpayer’s home. Because the IRS requires employers to withhold taxes for employees and issue them W-2s at the end of the year, the big question is whether or not that individual is a household employee.

Whether a household worker is considered an employee depends a great deal on circumstances and the amount of control the person hiring has over the job and the hired person. Ordinarily, when someone has the last word about telling a worker what needs to be done and how the job should be done, then that worker is an employee. Having a right to discharge the worker and supplying tools and the place to perform a job are primary factors that show control.

Not all those hired to work in a taxpayer’s home are considered household employees. For example, an individual may hire a self-employed gardener who handles the yard work for a taxpayer and others in the taxpayer’s neighborhood. The gardener supplies all tools and brings in other helpers needed to do the job. Under these circumstances, the gardener isn’t an employee and the person hiring him/her isn’t responsible for paying employment taxes. The same would apply to the pool guy or to contractors making repairs or improvements on the home.

Contrast the following example to the self-employed gardener described above: The Smith family hired Lynn to clean their home and care for their 3-year old daughter, Lori, while they are at work. Mrs. Smith gave Lynn instructions about the job to be done, explained how the various tasks should be done, and provided the tools and supplies; Mrs. Smith, rather than Lynn, had control over the job. Under these circumstances, Lynn is a household employee, and the Smiths are responsible for withholding and paying certain employment taxes for her and issuing her a W-2 for the year.

If an individual you hire is considered an employee, then you must withhold both Social Security and Medicare taxes from the household employee’s cash wages if they equal or exceed the $2,000 threshold for 2016.

The employer must match from his/her own funds the FICA amounts withheld from the employee’s wages. Wages paid to a household employee who is under age 18 at any time during the year are exempt from Social Security and Medicare taxes unless household work is the employee’s principal occupation.

Although the value of food, lodging, clothing or other noncash items given to household employees is generally treated as wages, it is not subject to FICA taxes. However, cash given in place of these items is subject to such taxes.

A household employer doesn’t have to withhold income taxes on wages paid to a household employee, but if the employee requests such withholding, the employer can agree to it. If income taxes are to be withheld, the employer can have the employee complete Form W-4 and base the withholding amount upon the federal income tax and FICA withholding tables.

The wage amount subject to income tax withholding includes salary, vacation and holiday pay, bonuses, clothing and other noncash items, meals and lodging. However, meals are not taxable, and therefore they are not subject to income tax withholding if they are furnished for the employer’s convenience and on the employer’s premises. The same goes for lodging if one additional requirement applies—that the employee lives on the employer’s premises. In lieu of withholding the employee’s share of FICA taxes from the employee’s wages, some employers prefer to pay the employee’s share themselves. In that case, the FICA taxes paid on behalf of the employee are treated as additional wages for income tax purposes.

A household employer who pays more than $1,000 in cash wages to household employees in any calendar quarter of either the current or the prior year is also liable for unemployment tax under the Federal Unemployment Tax Act (FUTA).”

Although this may seem quite complicated, the IRS provides a single form (Schedule H) that generally allows a household employer to report and pay employment taxes on household employees’ wages as part of the employer’s Form 1040 filing. This includes Social Security, Medicare, and income tax withholdings and FUTA taxes.

If the employer runs a sole proprietorship with employees, the household employees’ Social Security and Medicare taxes and income tax withholding may be included as part of the individual’s business employee payroll reporting but are not deductible as a business expense.

Although the federal requirements can generally be handled on an individual’s 1040 tax return, there may also be state reporting requirements for your state that entail separate filings.

If the individual providing household services is determined to be an independent contractor, there is currently no requirement that the person who hired the contractor file an information return such as Form 1099-MISC. This is so even if the services performed are eligible for a tax deduction or credit (such as for medical services or child care). The 1099-MISC is used only by businesses to report their payments of $600 or more to independent contractors. Most individuals who hire other individuals to provide services in or around their homes are not doing so as a business owner.

Please call this office if you need assistance with your household employee reporting requirements or need information related to the reporting requirements for your state

Better to Sell or Trade a Business Vehicle?

From time to time business owners will replace vehicles used in their business. When replacing a business vehicle, the tax ramifications are different when selling the old vehicle and when trading it in for a new vehicle. If the vehicle is sold, the result is reported on the taxpayer’s return as an above-the-line gain or loss. Since a trade-in is treated as an exchange, any gain or loss is absorbed into the replacement vehicle’s depreciable basis, thereby avoiding any current taxable gain or reportable loss.

Thus, it is generally better to trade in a vehicle that would result in a gain if it were sold and to sell a vehicle if doing so would result in a loss.

Let’s say a taxpayer sells a 100%-business-use vehicle for $12,000. The original purchase price was $32,000, and $17,000 is taken in depreciation. As illustrated below, the sale results in a loss, so it generally would be better to sell the vehicle and deduct the loss rather than trade in the vehicle.

On the other hand, had the business owner sold the vehicle for $16,000, the sale would result in a $1,000 taxable gain, and trading it in would be a better option.  Caution: Sales to the same dealer are treated as trade-ins.

If a vehicle is used for both business and personal purposes, the loss or gain must be prorated for the proportion of business use, as the personal portion of any loss is not deductible.
Since trade-in values are generally less than the sales value of the vehicle, the trade-in decision must also consider whether the tax benefits will exceed the additional money received from selling the old business vehicle. Of course, there is always the hassle of selling a car to be considered as well.

If you are considering trading a vehicle in, determine whether the tax benefits exceed the additional money received from selling the old business vehicle, as trade-in values are generally less than actual sales values. You should also consider the time and energy it will take to sell the vehicle on your own.

This concept can also be used when selling or disposing of other business assets. If you have questions about how this tax strategy might apply to your specific tax situation, please give this office a call.

Take Advantage of the IRA-to-Charity Provision

Individuals age 70.5 or over—who must withdraw annual required minimum distributions (RMDs) from their IRAs—will be pleased to learn that the temporary provision allowing taxpayers to transfer up to $100,000 annually from their IRAs to qualified charities has been made permanent. If you are age 70.5 or over and have an IRA, taking advantage of this provision may provide significant tax benefits, especially if you would be making a large donation to a charity anyway.

IRA-to-Charity Provision

Here is how this provision, if utilized, plays out on a tax return:

  1. The IRA distribution is excluded from income;
  2. The distribution counts towards the taxpayer’s RMD for the year; and
  3. The distribution does NOT count as a charitable contribution.

At first glance, this may not appear to provide a tax benefit. However, by excluding the distribution, a taxpayer with itemized deductions lowers his or her adjusted gross income (AGI), which helps for other tax breaks (or punishments) that are pegged at AGI levels, such as medical expenses, passive losses, taxable Social Security income, and so on. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.

If you think that this tax provision may affect you and would like to explore its possibilities, please call this office.

Proving Noncash Charitable Contributions

One of the most common tax-deductible charitable contributions encountered is that of household goods and used clothing. The major complication of this type of contribution is establishing the dollar value of the contribution. According to the tax code, this is the fair market value (FMV), which is defined as the value that a willing buyer would pay a willing seller for the item. FMV is not always easily determined and varies significantly based upon the condition of the item donated. For example, compare the condition of an article of clothing you purchased and only wore once to that of one that has been worn many times. The almost-new one certainly will be worth more, but if the hardly worn item had been purchased a few years ago and become grossly out of style, the more extensively used piece of clothing could actually be worth more. In either case, the clothing article is still a used item, so its value cannot be anywhere near as high as the original cost. Determining this value is not an exact science. The IRS recognizes this issue and in some cases requires the value to be established by a qualified appraiser.

Remember that when establishing FMV, any value you claim can be challenged in an audit and that the burden of proof is with you (the taxpayer), not with the IRS. For substantial noncash donations, it might be appropriate for you to visit your charity’s local thrift shop or even a consignment store to get an idea of the FMV of used items.

The next big issue is documenting your contribution. Many taxpayers believe that the doorknob hanger left by the charity’s pickup driver is sufficient proof of a donation. Unfortunately, that is not the case, as a recent United States Tax Court case (Kunkel T.C. Memo 2015-71) pointed out. In that case, the court denied the taxpayer’s charitable contributions, which were based solely upon doorknob hangers left by the drivers who picked up the donated items for the charities. The court stated that “these doorknob hangers are undated; they are not specific to petitioners; they do not describe the property contributed; and they contain none of the other required information.”

The IRS requires the following documentation for noncash contributions based on the total value of the donation:

  • Deductions of Less Than $250—A taxpayer claiming a noncash contribution with a value under $250 must keep a receipt from the charitable organization that shows:
    1. The name of the charitable organization,
    2. The date and location of the charitable contribution, and
    3. A reasonably detailed description of the property.

    Note: The taxpayer is not required to have a receipt if it is impractical to get one (for example, if the property was left at a charity’s unattended drop site).

  • Deductions of at Least $250 But Not More Than $500—If a taxpayer claims a deduction of at least $250 but not more than $500 for a noncash charitable contribution, he or she must keep an acknowledgment of the contribution from the qualified organization. If the deduction includes more than one contribution of $250 or more, the taxpayer must have either a separate acknowledgment for each donation or a single acknowledgment that shows the total contribution. The acknowledgment(s) must be written and must include:
    1. The name of the charitable organization,
    2. The date and location of the charitable contribution,
    3. A reasonably detailed description of any property contributed (but not necessarily its value), and
    4. Whether or not the qualified organization gave the taxpayer any goods or services as a result of the contribution (other than certain token items and membership benefits).

    If the charitable organization provided goods and/or services to the taxpayer, the acknowledgement must include a description and a good-faith estimate of the value of those goods or services. If the only benefit received was an intangible religious benefit (such as admission to a religious ceremony) that generally is not sold in a commercial transaction outside the donative context, the acknowledgment must say so, and in this case, the acknowledgment does not need to describe or estimate the value of the benefit.

  • Deductions Over $500 But Not Over $5,000—If a taxpayer claims a deduction over $500 but not over $5,000 for a noncash charitable contribution, he or she must attach a completed Form 8283 to the income tax return and must provide the same acknowledgement and written records that are required for contributions of at least $250 but not more than $500 (as described above). In addition, the records must also include:
    1. How the property was obtained. (for example, purchase, gift, bequest, inheritance, or exchange),
    2. The approximate date the property was obtained or—if created, produced, or manufactured by the taxpayer—the approximate date when the property was substantially completed, and
    3. The cost or other basis, and any adjustments to this basis, for property held for less than 12 months and (if available) the cost or other basis for property held for 12 months or more (this requirement, however, does not apply to publicly traded securities).

    If the taxpayer has a reasonable case for not being able to provide information on either the date the property was obtained or the cost basis of the property, he or she can attach a statement of explanation to the return.

  • Deductions Over $5,000—These donations require time-sensitive appraisals by a “qualified appraiser” in addition to other documentation. When contemplating such a donation, please call this office for further guidance about the documentation and forms that will be needed.

Caution: The value of similar items of property that are donated in the same year must be combined when determining what level of documentation is needed. Similar items of property are items of the same generic category or type, such as coin collections, paintings, books, clothing, jewelry, privately traded stock, land, and buildings. For example, say you donated $5,300 of used furniture to 3 different charitable organizations during the year (a bedroom set valued at $800, a dining set worth $1,000, and living room furniture worth $3,500). Because the value of the donations of similar property (furniture) exceeds $5,000, you would need to obtain an appraisal of the furniture to satisfy the substantiation requirements—even if you donated the furniture to different organizations and at different times during the year. The IRS has strict rules as to who is considered a qualified appraiser.

To help you document some of these noncash contributions, you can download a fillable Noncash Charitable Contribution statement. The statement includes an area for the charity’s agent to verify the contribution and a check box denoting whether the qualified organization provided any goods or services as a result of the contribution. Although not specifically blessed by the IRS, this statement includes everything needed for noncash contributions of up to $500—provided, of course, that you and the charitable organization’s representative accurately complete the form.

Do not include items of de minimis value, such as undergarments and socks, in the deductible amount of your contribution, as they specifically are not allowed.

Please call this office with any questions about documenting or valuing your noncash contributions.