Guide to Form 8594 and purchase price allocation (PPA)
When buying or selling a business, understanding tax implications is critical. The Internal Revenue Service (IRS) Form 8594 is essential for reporting the allocation of purchase price – a process that can significantly affect the tax liabilities of both buyer and seller.
What is Form 8594?
Form 8594, "Asset Acquisition Statement Under Section 1060," is a mandatory filing for buyers and sellers involved in selling a business's assets.
The form ensures that the buyer's depreciable basis in the assets is accurately determined and the seller's gain or loss from the sale is correctly calculated.
It also provides transparency in reporting the assets acquired and liabilities assumed in the transaction. Both parties must file this form with their individual tax returns for the year the sale occurs.
When must you file Form 8594?
You must file Form 8594 if:
- A group of assets that constitutes a trade or business is sold.
- Goodwill or going concern value is associated with the assets.
- The buyer's basis in the assets is determined solely by the price paid.
The form should be attached to your tax return for the year the sale is completed. If there are adjustments to the purchase price or allocation in later years, you must file an updated version of Form 8594.
Failing to file Form 8594 or providing inaccurate information can result in significant fines and penalties depending on the nature and duration of the error.
Why is purchase price allocation necessary?
Purchase price allocation is dividing the total purchase price of a business among its various asset classes. This allocation determines tax treatment for both buyer and seller:
- Buyers use the allocation to establish the basis for depreciation and amortization.
- Sellers calculate their gain or loss based on the allocated amounts.
Proper allocation requires thorough due diligence to ensure that the identifiable assets acquired are accurately valued and documented.
Buyer and seller allocations must match. Discrepancies may trigger IRS audits.
Asset classes defined on Form 8594
The IRS divides assets into seven classes, each with specific tax treatments. These classes, along with their implications, are as follows:
Class I: Cash and general deposit accounts, including savings and checking accounts. These assets are allocated at face value and are often excluded from the purchase price as they do not generate gains or losses.
Class II: Actively traded securities such as US government securities, publicly traded stock, and certificates of deposit. These are typically valued at face value and may not be included in the transaction unless explicitly agreed upon.
Class III: Accounts receivable, representing payments owed to the business. The seller often retains these assets, but if included, they are valued at their collectible amount to avoid disputes.
Class IV: Inventory or stock in trade, such as goods available for sale. These are valued based on the seller's original cost, minimizing tax liabilities for the seller and providing the buyer with an accurate basis for future deductions.
Class V: Other tangible property, including furniture, fixtures, equipment, and vehicles. These assets are usually appraised at their current market or replacement value. These assets are subject to depreciation for the buyer, while the seller incurs taxes based on ordinary income rates.
Class VI: Section 197 intangibles, which include items like customer lists, business records, trademarks, and licenses. These intangible assets are amortizable over 15 years, benefiting the buyer long-term. The seller must pay taxes based on capital gains or ordinary income, depending on the nature of the intangible.
Class VII: Goodwill and going concern value. These represent the premium paid for the reputation and operational continuity of the business. Goodwill is amortized over 15 years by the buyer, while the seller is taxed at capital gains rates.
Allocation is performed using the residual method, where assets in lower-numbered classes are assigned value first. Any remaining purchase price is then allocated to higher-numbered classes in order.
Purchase agreement and tax implications
The purchase agreement should explicitly state how the purchase price will be allocated among the different asset classes. This ensures that both parties are aligned and minimizes disputes.
For tax purposes, accurate allocation impacts the buyer’s depreciation and amortization schedules and the seller’s calculation of gain or loss.
The agreement should also identify any actively traded personal property included in the transaction to avoid valuation discrepancies.
Navigating Form 8594 and purchase price allocation requires precision. Professional support can ensure compliance and optimize outcomes for buyers and sellers. Reach out to a tax professional who can guide you through asset allocation and tax reporting complexities.
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Sign upDisclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional regarding your specific case.
Ines Zemelman, EA, is the founder and president of TFX, specializing in US corporate, international, and expatriate taxation. With over 30 years of experience, she holds a degree in accounting and an MBA in taxation. See more
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