After the corporation pays the tax, the balance would then be paid to the agency's shareholders. But that is income to each shareholder and he/she will have to pay capital gains tax on that income! And the above scenario doesn't even factor in state income taxes. It is quite possible that if the deal is structured improperly, the seller could take home less than 50% of the sales price!
If the seller converted from a C to an S corp, he or she normally has to wait 10 years before being able to sell and avoid double taxation. However, this 10-year waiting period drops to five years for 2011 only. (See chart)
Allocation of the Purchase Price Typically the purchase price is allocated among: -Corporation Goodwill -Expiration/Book of Business -Personal Goodwill -Fixed Assets -Non-Compete/Non-Piracy Agreement
Let's assume you need to sell, and you are a C Corporation, or you recently converted from a C Corp to an S Corp and donâ€™t fit the window in the chart to the right. Depending on how much of the book of business is controlled by the agency owners, how long they have owned the agency, and whether they have signed covenants not to compete, some of the purchase price may be allocated to goodwill. A partial allocation to personal goodwill can help reduce the double taxation penalty.
However, for C Corporations, the higher the allocation to personal goodwill, the greater the chance the IRS will take a jaundiced look at the transaction. In most situations, going over a 40% or 50% allocation for personal goodwill is just begging for trouble.
As the seller, you also will want to minimize the amount of the purchase price allocated to fixed assets or a non-compete agreement. Any amount allocated to fixed assets over and above the book value of the assets will be considered a recapture of depreciation and will be taxed at ordinary income tax rates to the seller. Non-Compete agreements also are treated as ordinary income to the seller and taxed at the ordinary tax rate as opposed to the lower capital gains rate.
Estate Planning George Steinbrenner died in the right year. In 2010 there was no Federal estate tax. None of his estate was subject to Federal estate tax and it passed to his heirs. Starting in 2011, the Federal estate tax rate is 35% on any estate value in excess of $5 million. If your total net worth, including the agency, exceeds $5 million, you should sit down with an estate planner to discuss your personal situation. He/she will probably suggest that you have your agency valued as part of the planning process. Make sure you hire someone that understands insurance agencies and specializes in agency valuation.
Summary Tax law is constantly in flux, and the buying and selling of insurance agencies are complicated deals. Many CPAs and attorneys don't understand the nuances of our industry or the true value of an insurance agency. This article only touches on the ways taxes, timing, and allocation can affect how much the retiring owner gets to keep. Its intent is to make agency owners mindful of some opportunities and pitfalls. After all, many agency principals work at one agency for their entire lives and will only ever have that one agency to sell.
About the Author: Jon Persky, CPA, CIC, PHR Jon is the president of Optimum Performance Solutions, LLC (www.optperform.com), an insurance agency consulting firm providing valuation, merger and acquisition, agency perpetuation, strategic planning, and marketing and retention services to insurance agencies nationwide. Jon is the author of Maximizing Agency Value II as well as Managing Human Resources in an Insurance Agency). He is also a member of the CIC national faculty.