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Jax Tax
Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1377
Experience:  JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions
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Hi, I have a client who started a business in 2008.

Resolved Question:

Hi,
I have a client who started a business in 2008. She is selling this business in 2011.
I need to know how to figure the cost basis of this business. I have the furniture, equipment improvement figures and inventory, but I don't know how to calculate the "Goodwill", the value of the owners time to create the business and "the covenant not to compete". The business is "exercise classes, with some retail clothing and a small
cafe.
2008 Gross income= 163,851, profit 8,197.
2009 Gross income= 194,301, profit -485.
2010 Gross income= 225,783, profit-3,581.
Also I know the buyer needs to pay sales tax on the furniture & equipment, but I'm not sure if sales tax must be paid on the existing inventory, which amounts to approx. $20,000. Thank You, XXXXX XXXXX
Submitted: 3 years ago.
Category: Tax
Expert:  Jax Tax replied 3 years ago.

Jax Tax : We need to start from the beginning. You state the business is being sold. What is the business structure? Is it a stock sale or asset sale? Let's start there.
Jax Tax : Why would there
Jax Tax : So, I will await that response and answer as if it is a asset sale. How the value is determined is by hiring a professional appraiser. How the pro values assets is based on strict regulations.
Jax Tax : The IRS dictates what accounting method to use to allocate the value of the assets. Called the residual method, the allocation system creates four classes of assets a business can sell:Class I: Cash, demand deposits, bank accounts;Class II: Certificates of deposit, equity securities, U.S. government securities, foreign currency;Class III: All assets other than Classes I, II and IV, tangible and/or intangible, whether or not they are depreciable or amortizable. These include inventory accounts receivable and fixed assets; andClass IV: Those intangible assets in the nature of goodwill (also known as going concern).If the seller doesn’t have substantial capital losses, he or she receives no tax benefit in allocating part of the sales price to goodwill as opposed to other deductible assets. On the other hand, the buyer benefits if allocations can be made to deductible assets.A valuation of a business’s Class III assets, such as inventory, accounts receivable, fixed assets and identifiable intangible assets is extremely important. Such a valuation can act as a strong foundation for the required allocations, and the IRS will be less likely to question them.The Process of Valuing AssetsUnder a priority system established by the regulations, the purchase price is allocated based on the relative fair market values of the company’s various assets, first to Class I assets, then to Class II assets and finally to Class III assets.Any unabsorbed excess purchase price is allocated to Class IV assets: goodwill and going-concern value.Particularly when a purchase involves a premium price, identifying and valuing Class III intangibles becomes crucial. Most of these assets are amortizable for tax purposes. To maximize tax deductions, a buyer should make sure that all Class III assets are recognized.
Customer :

The sale would be an asset sale. I need to get some more information from the client.

Customer :

Also The sales price for the business. I'll e-mail you again when I get the additional info.

Customer :

Thanks Again, Fred

Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1377
Experience: JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions
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