C corp asset sale

[jklcpa]

I have a c corp selling its business as an asset sale.  The part of the purchase for the covenant not to compete has been carved out and being sold by the individual shareholders.  Other than than, it's F&F, improvements, and goodwill. I don't know why nothing has been assigned to inventory, it would be a very small amount compared to the total, and I'll get an answer on that tomorrow.  Goodwill isn't that of the individual shareholders, it's being sold by the corporation. The amount allocated to the sale of goodwill % is ~ 39% of the price of those 3 items being sold by the C corp, and would be 29% of the total including the covenant.

The amounts allocated to F&F and improvements each exceed the net book value of those items on the c corp's books, but one problem I see with the allocations already is that the amount allocated to F&F exceeds the original purchase price of those assets on the corp's books, and in IRC sec 1060, the rules say that allocations to the items before arriving at goodwill can't exceed FMV.  There's no way that these have appreciated, so that needs to be revised.

Once that is resolved, from the seller's perspective, is there any reason to consider further tweaking the allocation among the categories of assets that will be sold by the corp?   

[BulldogTom]

I will give this a shot at the risk of showing my ignorance.

1.  Individuals selling their covenant not to compete seems to be ordinary income to the shareholders.  They have no basis in a promise.  That is not part of the sales price for the C Corp because it is not selling its promise, the individuals are.  That should be a separate sale, with separate documentation executed as a condition of the corporate sale of assets.

2.  Inventory has to be addressed.  It is a hot asset and needs to be classified as such.  Anything about AR?  Contracts in progress?

3.  Identify the goodwill.  Is it a customer list?  Name?  Process of some kind? Reputation? Website address?  All of the above.

4.  I assume that as smart as you are, you have not confused book value with Fair Market Value of the hard assets.   Just mentioning...because it is something that I need to always remind myself of.

I think if you pull the covenant out of the sale, your numbers might make more sense in regards to if the sales price exceeds the FMV of the assets.  If it still does, you need to bring that up to the seller.  But since FMV is the price at which a willing buyer and a willing seller agree upon, you might be OK if it is not too extreme.

I hope this does not sound to basic.  I just did not want your post to sit out there thinking no one read your post.

Tom
Newark, CA

[jklcpa]

1 hour ago, BulldogTom said:

I will give this a shot at the risk of showing my ignorance.

1.  Individuals selling their covenant not to compete seems to be ordinary income to the shareholders.  They have no basis in a promise.  That is not part of the sales price for the C Corp because it is not selling its promise, the individuals are.  That should be a separate sale, with separate documentation executed as a condition of the corporate sale of assets.

2.  Inventory has to be addressed.  It is a hot asset and needs to be classified as such.  Anything about AR?  Contracts in progress?

3.  Identify the goodwill.  Is it a customer list?  Name?  Process of some kind? Reputation? Website address?  All of the above.

4.  I assume that as smart as you are, you have not confused book value with Fair Market Value of the hard assets.   Just mentioning...because it is something that I need to always remind myself of.

I think if you pull the covenant out of the sale, your numbers might make more sense in regards to if the sales price exceeds the FMV of the assets.  If it still does, you need to bring that up to the seller.  But since FMV is the price at which a willing buyer and a willing seller agree upon, you might be OK if it is not too extreme.

I hope this does not sound to basic.  I just did not want your post to sit out there thinking no one read your post.

Tom
Newark, CA

Tom, thanks for the reply.

The total price is 1.12 million, covenant is carved out at $300K for personal reporting, and yes, it will be ordinary income.

It's a sale of a family owned & run combo take-out/eat-in cafe with small bar area. No A/R. Inventory is perishable food, soft and hard beverages and won't be a large number in the total package.  Yesterday was the first time I saw the numbers and breakdown, and was surprised at no inventory and have asked about that.  Of the remaining sale price, tentatively it was F&F 400K, Improvs $100K, Goodwill $320K.

Goodwill is mainly attributable to the name and reputation (not a chain or franchise), trained and stable work force, and stability of the business. It might have a stable customer base, but for this type of business I don't see that has having a value as other businesses might have. Goodwill wouldn't be attributable to the owners' involvement in the process or any kind of specialize knowledge.

I didn't confuse the NBV and FMV. I only stated that to say that cost of assets has been depreciated down to the point that I know the value assigned will definitely create a gain in the corp. Many of the F&F assets are at -0- NBV because of either using sec 179 or their age and being fully depreciated. My point was that the original cost per books for these used assets was only ~ $350K and the sale price tentatively assigned to it is $400K for some of these old, used assets, so I kind of thought that might not be in the range of reasonableness.

I hear what you are saying about the price assigned is between a willing buyer and seller, but doesn't it seem that the $400K might be too high considering their age and historical cost?  That's why I asked, because I was really unsure on that point and thought that after dealing with some amount for inventory that less should go to fixed assets and more to goodwill. 

[BulldogTom]

The new owners probably want the faster depreciation on the fixtures. 

And just to be argumentative, in a restaurant, those stainless steel tables, commercial refrigeration, and commercial ovens and stoves retain their value.  And they are all installed and ready to use.  Personally, I would not sweat it based on the valuations they are using.  It passes the smell test, especially when you add in all the stuff that was not on the balance sheet that is going in to the sale (think knives, slicers, pans, pots, dishes, eating utensils, all commercial grade and built to last a lifetime).  Also, you have all the glassware for the bar.

It passes my smell test from 3000 miles away.  But I will not be signing the tax return.

Tom
Newark, CA

[jklcpa]

Thank you. I really appreciate the input and I don't think you're argumentative at all. These are the things I'm not clearly thinking of being too close to the situation, and this is exactly the type of discussion I was looking for.  I agree, the buyer will want that faster write off and is pushing as much to F&F as he can.

[DANRVAN]

It is very clear in section 1060 that the allocated price of the assets can not exceed FMV and the inventory must be allocated before the FF and improvements.

Since 1060 requires the use of the residual method, it looks like the ordering in this case would be: inventory, FF  &  improvements, and then the residual would be allocated to goodwill. I  don't think you really need to be concerned about the detail of goodwill; it is what the buyer is willing to pay above the fmv of  the business assets.

Since the corporation has no right to tell the shareholders what to do, the covenant not to compete is a separate transaction outside the corporation.

In regards to your client, I don't think the final allocation will make a lot of difference since there is no capital gain break for the corporation. They just need to be informed of the correct procedures.

[Abby Normal]

Inventory is usually an additional amount above the asset sales price, because inventory varies constantly.

And since this is a C corp, the tax rate is the same for gains on depreciated assets and goodwill. The IRS is normally concerned if too much is allocated to goodwill in an S corp or sole prop, to take advantage of capital gains rates, and avoid depreciation recapture at ordinary income rates for the seller.

[jklcpa]

I agree with you both and am aware that this will all be taxed at the regular corporate rates.

I realize that the covenant isn't part of this corporate sale, but I included in in the detail of my post so that Tom could see that it wasn't part of the figures I was discussing.  I also included the details of goodwill to show that it realistically can't be attributed to the owners and will be part of the sale within the C corp.

Inventory will be determined at the close of business immediately before settlement for the sale and will be plugged in to the final breakdown so that, because the sales price will not be increased for inventory and the class V asset allocations will have been decided on, the effect will be that using the residual method will cause the goodwill to be reduced by the amount of the inventory value.

They're working on revising the figures for the class V assets after I sent the owner an email about F&F being allocated too high, and too low on improvements.  I was just there this morning explaining all of this to the owner, and then came back to the office to find an email from the corp's attorney asking about the same issue.