Accting/Tax question when buying a business

J

John47

Hi all. I'd appreciate some knowledgeable responses here!

I am getting ready to buy a business. The seller's asking price is 600k, he wants 300k down and he's willing to finance the other 300k for 7yrs with no interest (about 43k/yr).

The seller is using a business broker who's commission is 10%. So am I right in saying that when we close on the business, he will receive 300k...and have to pay 60k in commission, and have to set aside about 90k in capital gains (15% of 600k)....leaving him with only 150k (assuming no write offs)...and 43k a year for 7 years.

Instead of him financing, I want to draw up a contract to pay him as a consultant for 7 years. That way, the sale price, commission, and taxes for him are all dramatically lower. Am I right to say that we could arrange it such that, using the same amounts as above....the sale price is now 300k...and he pays 30k commission, and 45k cap gains, leaving him with 225k. He's contracted as a consultant and gets a 1099, on 43k a year he will pay 15% soc/med tax, and income tax of 15% (more tax on the back end than he pays in the first situation, but this way he gets much more money up front).

Am I right in saying the second situation is much more advantageous for him (and also me)??? Thank you in advance for any help.
 
I've made similar type deals as this in the past, so I can offer a few points of interest to chew on.

- I only have reported the down payment to be calculated as cap. gains as a seller because I have yet to "realize" the actual gain. The remainder is to be amortized and taxed yearly.

- His tax rate may or may not be 15% of the 1099 figure, depending on his other income, because, unless I am mistaken, he will be filing a schedule C as a subcontracted consultant. If so, double the med and SS tax for self employment tax.

- Your situation is a little better in the short term by going the consultant route, because you get to deduct the 1099 payouts from your yearly income. However, the cost basis, when and if you decide to sell it will be dramatically lower, setting yourself up for a big cap. gains bite. Also, the tax laws for cap. gains may change at that time, possibly not in your favor.

Of course, I am just an ananymous forum poster and my BEST advice is to spend a few hundred on a good CPA and get the scoop from a professional.
 
Not enough information.
Is it a corp, sole proprietor, LLC…?
What type of business manufacturing (hard assets, inventory), some kind of consulting practice (mostly customers).
With 600K you do not own the business until the last penny is paid (previous owner can get it back if you default).
With 300K you own the business out right. Can you cancel his consulting agreement? I am sure you can. He will have to sue you for none performance (more legal fees) and the one who can tell a better story or has better attorney wins. (I am assuming non relative transaction since using a broker).

To other poster:

You calculate your SE tax on schedule C, your P&L from SE activity rolls into 1040 and you deduct half of your SE tax to arrive at AGI (adjusted gross income) that is the bases for your personal taxes.
 
I want to draw up a contract to pay him as a consultant for 7 years.
============

Just curious, what will be his security for the 300k if he is a consultant, will it still be the property. How will the IRS look at a no interest loan. Wouldn't you think if you defaulted and he took back the business, the whole process was to avoid taxes esp a loan with no interest via a consultant.

Something is not priced right in the business if it entails a profit by avoiding taxes.

Of course, just wondering.
 
In any case offer what is the most advantageous to you and work it from there, let the other side worry about his money.

You cannot tell what is the most advantageous to the other person without having complete knowledge of his estate. Can he offset his gains by selling some loosing stocks?
 
Quote from Big AAPL:

I've made similar type deals as this in the past, so I can offer a few points of interest to chew on.

- I only have reported the down payment to be calculated as cap. gains as a seller because I have yet to "realize" the actual gain. The remainder is to be amortized and taxed yearly.

- His tax rate may or may not be 15% of the 1099 figure, depending on his other income, because, unless I am mistaken, he will be filing a schedule C as a subcontracted consultant. If so, double the med and SS tax for self employment tax.

- Your situation is a little better in the short term by going the consultant route, because you get to deduct the 1099 payouts from your yearly income. However, the cost basis, when and if you decide to sell it will be dramatically lower, setting yourself up for a big cap. gains bite. Also, the tax laws for cap. gains may change at that time, possibly not in your favor.

Of course, I am just an ananymous forum poster and my BEST advice is to spend a few hundred on a good CPA and get the scoop from a professional.
More...

I really appreciate the response. There are going to be plenty of cpa's and lawyers involved when the contract is drawn up...right now we're just trying to figure out what options we have to structure the deal.

His tax rate may or may not be 15% of the 1099 figure, depending on his other income, because, unless I am mistaken, he will be filing a schedule C as a subcontracted consultant. If so, double the med and SS tax for self employment tax.

He will probably be 1099 from us on 43k/year. So you're saying he may have to pay 30% soc/med tax plus income tax? Meaning he'll end up paying a total of 45% taxes??? Or am I misreading...that seems awfully high.

Thanks again.
 
Quote from nutmeg:

I want to draw up a contract to pay him as a consultant for 7 years.
============

Just curious, what will be his security for the 300k if he is a consultant, will it still be the property. How will the IRS look at a no interest loan. Wouldn't you think if you defaulted and he took back the business, the whole process was to avoid taxes esp a loan with no interest via a consultant.

Something is not priced right in the business if it entails a profit by avoiding taxes.

Of course, just wondering.
More...


The businesses are three restaurants. No real estate owned. Structured as 2 LLC's....I will form 3.

As a consultant nothing will secure his money, but I'd be willing to sign any contract his lawyer could draw up that would be fair to him. As well, his son is staying on to work for me, and he'll be on for awhile as well so its not like a real clean break anyway.

I just talked to a CPA and he said it would be more advantageous to me to pay him as a consultant, but not for him (he'd pay too much taxes on the residual income).

I think the money down is more important to this guy though, so avoiding the big commission would probably be more important.

Thank you for all the responses.
 
Quote from John47:

I really appreciate the response. There are going to be plenty of cpa's and lawyers involved when the contract is drawn up...right now we're just trying to figure out what options we have to structure the deal.

His tax rate may or may not be 15% of the 1099 figure, depending on his other income, because, unless I am mistaken, he will be filing a schedule C as a subcontracted consultant. If so, double the med and SS tax for self employment tax.

He will probably be 1099 from us on 43k/year. So you're saying he may have to pay 30% soc/med tax plus income tax? Meaning he'll end up paying a total of 45% taxes??? Or am I misreading...that seems awfully high.

Thanks again.
More...

Self employed pays same tax as any other person.
On schedule C it is calculated as half for employer and other half for employee for P&L reasons only.
Total income from schedule C rolls in another form (1040) where it becomes your total income. If you are self employed person you get to deduct half of self employment tax to get to another figure AGI.

There is no double taxation when you are self employed.

Example:

SE person paid $1,000 as an employee and another $1,000 as an employer a total payment of $2,000

On your 1040 you deduct $1,000 from your income.
 
This is true what Gann says, but it is my understanding that the SS and Med. portions of ones tax liability (SE individuals) are doubled THEN one half is deducted from the 1040 form. The payment still has to be made, but your taxable income is reduced by half that amount.
 
Quote from John47:

Hi all. I'd appreciate some knowledgeable responses here!

I am getting ready to buy a business. The seller's asking price is 600k, he wants 300k down and he's willing to finance the other 300k for 7yrs with no interest (about 43k/yr).

The seller is using a business broker who's commission is 10%. So am I right in saying that when we close on the business, he will receive 300k...and have to pay 60k in commission, and have to set aside about 90k in capital gains (15% of 600k)....leaving him with only 150k (assuming no write offs)...and 43k a year for 7 years.

Instead of him financing, I want to draw up a contract to pay him as a consultant for 7 years. That way, the sale price, commission, and taxes for him are all dramatically lower. Am I right to say that we could arrange it such that, using the same amounts as above....the sale price is now 300k...and he pays 30k commission, and 45k cap gains, leaving him with 225k. He's contracted as a consultant and gets a 1099, on 43k a year he will pay 15% soc/med tax, and income tax of 15% (more tax on the back end than he pays in the first situation, but this way he gets much more money up front).

Am I right in saying the second situation is much more advantageous for him (and also me)??? Thank you in advance for any help.
More...

SAIP but he will taxed a captial gain rate at the sale. If you pay him in 1099 income it will be at ordinarly rates.

He is better taking the captial gain tax for the sale and you carry a note that you pay to him. The note will be a return of capital.

Other wise he will be payin 15% a year in social secruity tax.
 
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