You probably wouldn’t think of making an investment recommendation to your clients without first considering the tax consequences. Not that the tax consequences would be the determining factor in your recommendation, but they would be a point that would require careful deliberation. Taxes can make or break an investment outcome, as you know all too well.
The same is true with your potential advisory practice transaction.
Whether you’re on the buy or sell side, taxes are a major component. As a seller, your tax liability will directly impact your take home pay. As a buyer, tax deductions related to depreciation and interest payments could impact your bottom line and your ability to service any outstanding debt.
Much of the tax liability will be based on how the transaction is structured. Advisory practice transactions are usually done three different ways:
- Stock sale
- Asset sale
- Revenue share/consulting agreement
Once you know how the deal may be structured, you can start to analyze all of the possible tax consequences. Here are a few ways that the deal type can impact the tax ramifications.
In this type of transaction, the stock of the firm is sold to the buyer. All of the company’s assets and liabilities are also transferred to the buyer.
The seller records a gain, so he or she will pay capital gains taxes on the difference between his or her basis in the stock and the purchase price. The buyer will realize depreciation on the assets and may be able to deduct interest on some of the liabilities.
In this type of transaction, the buyer doesn’t necessarily purchase the entire firm, but rather purchases the assets directly. The assets are then brought into his or her firm.
For the seller, capital gains taxes are still due, but they’re based on the difference between basis and purchase price on each individual asset. This may require a little more calculation to come up with an accurate projection.
For buyers, they’re still realize depreciation on the purchased assets. However, unless otherwise negotiated, asset sales usually don’t transfer liabilities. The liabilities are typically paid off by the seller using the proceeds. That would eliminate any deductions for interest paid, but would also reduce the debt service liability.
Revenue sharing/consulting arrangements
In these agreements, the selling advisor stays on with the practice. The buyer joins the practice and takes over day-to-day management, either gradually or immediately. In return, the buyer pays the seller a share of revenue or an annual consulting salary for a limited period of time.
Under this arrangement, the seller may avoid capital gains taxes, but he or she would likely incur ordinary income taxes based off of the income. The buyer may be able to deduct those payments, but would also have an obligation to make the payments as negotiated.
Keep in mind, too, that transactions can be structured in a variety of ways. Your deal may involve a stock purchase with a revenue sharing agreement. There’s no boilerplate structure, so it’s important to consider all the options before committing to one path. Do your due diligence with regard to taxes so you can make the best decision for your firm.