Topics: Asset, Balance sheet, Capital asset Pages: 11 (2359 words) Published: January 15, 2015

To: Shahab Razani, Tax Partner
From: Chinonso Nwogu, Tax Advisor
Date: January 3, 2014
RE: Tax Consequences and Compliance of Assets Acquisition

On December 1, 2012, Environmental Solutions Inc., (“Environmental”) offered to buy Joel Freedman’s (“Freedman”) company, Advanced Technologies. After discussing the offer with his attorney, he accepted to sell his company on August 1, 2013. On August 15, 2013, attorneys from both companies signed a letter of intent to acquire Advanced Technologies assets and liabilities for $5million. On September 30, 2013, the letter of intent was presented and approved by Environmental Solution’s board of directors. On October 15, 2013, the acquisition was completed and closed. Freedman established a sole proprietorship, Advanced Technologies, in 2009 after discovering a new technique that efficiently and effectively removes hazardous waste. He immediately patented this technology. In Advanced Technologies financial statement, the company disclosed the lawsuit brought against it by previous employees in the footnotes of its financial statement. After acquiring Advanced Technologies, Environmental decided to settle the lawsuit for $1million. ISSUES

1. Whether a payment made by a buyer in discharge of a contested contingent tort liability, first asserted against the seller is and assumed by the buyer upon acquisition of seller’s assets pursuant to IRC §§ 263 and 338 should be capitalized by the purchaser? 2. How the payment received from the sale of an ongoing business must be allocated to assets and how the character of the gain or loss should be classified pursuant to IRC §§ 1060 and 338. 3. How the purchase price of an ongoing business should be allocated between certain specified categories of assets based on the relative fair market value under IRC §§ 338and 1060? CONCLUSION

The seller and buyer must both follow the IRS rules by reporting the sale and attaching Form 8594, Asset Acquisition Statement to the income tax return. 1. In the assumption of a liability (asserted to a seller first) by a buyer upon the acquisition of a seller assets, the payment has to be capitalized rather than deducted by the buyer under IRC § 263. Basically, if a cost is found to be related to the seller’s operation of business, the cost of liability has to be capitalized. In the case of Environmental Solutions, the contingent liability rose directly from the seller’s operation prior to acquisition, therefore, it is capitalized.1 Second, the payment made for the acquisition of assets should be allocated of the basis of certain assets specified on Form 8954. Third, the payment from acquisition of assets should be allocated before any gain or loss can and will be computed or realized. 2. The payment received in the allocation of the sale price based on the classification of each asset. An acquired asset from the sale of a business cannot all be treated as capital assets because some assets are considered ordinary income assets either because of IRC § 1245 recapture or the classification of the asset by the codification as ordinary. Examples of ordinary income assets are Account Receivable, inventory and equipment (recapture). The Account receivable and inventory resulted in an ordinary loss of $10000 and $25000 respectively, while the equipment produced an ordinary gain of $20000. The capital Assets produced capital gains (goodwill $3million; patent $975000 and building $400000), however, due to the recapture in building, an ordinary gain of $10000 was recognized. 3. It is well settled that when a taxpayer acquires an asset for lump sum, the price is allocated among the assets acquired in accordance with the relative Fair Market Value and this allocation is to specific assets. ANALYSIS

Issue 1
Treatment of Assumed Contingent Liability by a Buyer in Pre-acquisition Several factors are used in determining whether a liability is an assumed liability. Two of the factors for this...
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