In previous articles the Residual Method has been discussed in regards to allocating the consideration paid for a business. As you may recall, the residual method requires the consideration paid to be allocated amongst classes of assets in a particular order. The article below has been prepared by a tax attorney at The McGuire Law Firm to provide information regarding the classes of assets that would apply to the residual method. Please remember that the information below is for informational purposes and it is recommended that you discuss any business transaction with your business attorney and/or tax attorney.
Below are a list of the classes of assets and definitions of such classes for a deemed asset acquisition or an actual asset acquisition. With the exception of an asset within Class VII, the amount that is allocated to an asset, may not exceed the fair market value of the asset as of the purchase date of the asset. Furthermore, amounts allocated to an asset can be subject to limits under the IRS or other tax law principles.
– Class I: Cash & general deposit accounts
– Class II: CODs, US Government Securities, foreign currency, securities (stock)
– Class III: Debt instruments, accounts receivable
– Class IV: Property of a kind that would be included within inventory
– Class V: All assets that would not be included within the other classes
– Class VI: IRC Section 197 intangibles apart from goodwill and going concern
– Class VII: Goodwill and going concern
It is important to remember that if an asset could be included within multiple classes, the proper classification would be the lowest of all classes of which the asset could be included. For example, if an asset could be included in Class II or Class III, you would allocate the asset, or consideration paid for the asset in Class II.
For example, assume the company J Cubed sells its assets for $50,000. J Cubed sold $20,000 in deposit accounts and inventory with a fair market value of $15,000. Thus, of the $50,000 paid for J Cubed assets, $20,000 would be allocated to general deposit accounts, $15,000 to inventory (Class IV) and the remaining $15,000 to goodwill and going concern.
When the seller and buyer enter into the asset purchase agreement, the parties can draft the asset purchase agreement allocating the consideration to the assets. This agreement will be binding on the parties (both buyer and seller) unless the allocation of the consideration is challenged by the Internal Revenue Service, and it is determined that the allocation within the agreement is improper.
You can speak with a Denver tax attorney or Denver business attorney at The McGuire Law Firm regarding the tax and transaction issues related to the sale or purchase of a business. Contact The McGuire Law Firm and schedule a free consultation with a tax attorney in Denver Colorado. The McGuire Law Firm has offices in Denver, Colorado and Golden, Colorado for your convenience.