Members of our Business and Corporate Practice Group have seen a number of deals recently where an overreaching buyer to an asset purchase transaction attempts to maintain sole authority to allocate the purchase price. Purchase price allocation has a direct impact on the seller's net after-tax proceeds, the buyer's net after-tax cash flow and basis in the purchased assets. Allowing one party to make the allocation unilaterally, or ignoring the purchase price allocation altogether, can lead to post-closing tax surprises and adverse financial consequences. This is primarily because an allocation which is beneficial to one party is typically detrimental to the other party.
In every deal structured (or treated for tax purposes) as an asset purchase, the parties must allocate the purchase price to the purchased assets and report the agreed-upon allocation to the IRS. Generally speaking, buyers want to allocate as much of the purchase price as possible to asset classes that can be quickly depreciated (e.g., tangible personal property) or expensed when paid (e.g., post-closing services). On the other hand, sellers typically want to allocate as much of the purchase price as possible to asset classes where they can treat their income as capital gains rather than ordinary income (e.g., goodwill).
The IRS will typically defer to the parties' allocation so long as it is reasonable and was negotiated at arms-length. Therefore, we highly recommended that parties to asset transactions include the allocation itself, or at least a post-closing allocation formula, in the purchase and sale agreement. Additionally, we encourage our clients to consider the purchase price allocation as a necessary element to the negotiation of the legal and business deal terms.
As with most complex legal matters, purchase price allocation can have significant tax ramifications if it is not promptly and properly managed. Our Business and Corporate attorneys understand the strategic importance of allocating purchase price in asset transactions, and work hand-in-hand with our firm's Tax Planning Practice Group to best utilize the established purchase price allocation rules to our clients' benefit.
For more information on this Client Update, please contact Jeffrey B. Cianciolo, Esq. on his direct line at 401-490-0219 or Marcus I. Howell, Esq. on his direct line at 401-655-2209.