The way the purchase price is allocated directly impacts your final, after-tax proceeds. An allocation that favors goodwill is typically taxed at the lower capital gains rate for you. An allocation that favors other assets, like a non-compete agreement or equipment, can result in a higher tax bill because it’s treated as ordinary income or reduces the buyer’s future tax burden instead of yours. This makes the allocation a key point of negotiation.
Example in Healthcare M&A
Scenario: A two-physician orthopedic group agrees to sell their practice to a regional hospital system for $4 million. The practice has medical equipment with a depreciated book value of $150,000 but a fair market value of $400,000.
Application: During the PPA negotiation, the hospital’s accountants propose allocating a high value of $1 million to a non-compete agreement and $400,000 to the equipment. This benefits the hospital, as they can amortize and depreciate these items to get near-term tax deductions. Your advisors counter that the practice’s strong reputation and referral network justify a higher allocation to goodwill.
Outcome: After negotiation, you agree to a final allocation: $500,000 to the non-compete agreement and $2,500,000 to goodwill. By shifting value to goodwill, you ensure a larger portion of your proceeds are taxed at the favorable long-term capital gains rate, significantly increasing the amount of cash you take home from the sale. Both parties must sign IRS Form 8594 reflecting this agreed-upon allocation.
Related Terms
- Asset Purchase – The most common transaction structure where Purchase Price Allocation is required.
- Adjusted EBITDA – The profitability metric that often determines the total purchase price before it is allocated among the assets.
- Due Diligence – The buyer’s investigation process where they examine the very assets that will be valued in the PPA.
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Frequently Asked Questions
What is Purchase Price Allocation (PPA) and why is it important?
Purchase Price Allocation (PPA) is the process of assigning the total purchase price of a business acquisition to its various assets and liabilities. It is important because it affects the tax treatment of the proceeds for the seller and the tax benefits for the buyer. An allocation favoring goodwill is taxed at a lower capital gains rate, benefiting the seller, while an allocation favoring other assets may result in higher taxes for the seller but future deductions for the buyer.
How does allocating more value to goodwill affect the seller’s tax outcome?
Allocating more value to goodwill typically results in the seller’s proceeds being taxed at the lower capital gains rate. This means the seller pays less tax on the sale and takes home more cash after taxes.
Why might a buyer want to allocate a high value to a non-compete agreement or equipment?
A buyer might allocate a high value to a non-compete agreement or equipment because these assets can be amortized or depreciated, generating near-term tax deductions for the buyer. This reduces the buyer’s future tax burden.
In the healthcare M&A example, what was the final agreed allocation between non-compete agreement and goodwill?
The final agreed allocation was $500,000 allocated to the non-compete agreement and $2,500,000 allocated to goodwill. This allocation favored the seller by increasing the portion of proceeds taxed at the favorable long-term capital gains rate.
What official document must both parties sign to reflect the agreed-upon Purchase Price Allocation?
Both parties must sign IRS Form 8594 to reflect the agreed-upon Purchase Price Allocation.