Tax Implications of Selling a Financial Advisory or Planning Practice

Selling a financial advisory practice — or a financial planning practice — involves more than simply agreeing on a price and signing documents. One of the most significant, and often unexpected, factors that both buyers and sellers face is the tax impact of the transaction.

From deal structure to the treatment of goodwill, every decision can affect how much each party keeps after taxes. Whether you are selling your practice to retire, merge with another firm, or expand your client base through acquisition, understanding these tax implications is essential.

To shed light on the most important considerations, we spoke with Alan Salomon, CPA/ABV, CVA, who provided an overview of what buyers and sellers can expect.

Deal Structure When Selling a Financial Advisory or Financial Planning Practice

According to Salomon, in general, there are typically two ways to structure any business acquisition. The first, is an approach whereby the “individual assets of the business are sold, less any applicable liabilities. This asset-based approach, as it relates to financial service businesses, generally only considers goodwill, as often times there are little to no fixed assets on the books of the business, and any liabilities tend to stay with the seller.” The other option is to “transfer an ownership interest, such as stock or a membership interest in an LLC.” Since ownership of most financial service businesses is at the individual level (sole proprietorships) acquisitions involving the transfer of stock or a membership interest in an LLC are typically not relevant.

Understanding Enterprise vs. Personal Goodwill in Practice Sales

Salomon goes on to indicate that there are two types of goodwill and breaks down the differences below:

1. Enterprise Goodwill: The goodwill that stays with the business, regardless if the current business owner were to leave that business. This type of goodwill is applicable to situations where someone connects with a business because of familiarity with the name of the company, location, or systems that it has in place. For example, someone may stay with a financial advisory practice simply because they like getting monthly statements in a format that they are used to.
2. Personal Goodwill: This type of goodwill attaches to the individual business owner simply because of his/her good name, reputation, or personal relationship. Clients of financial service businesses generally are consistent with this type of goodwill.

Because personal goodwill is common in this industry, buyers should include a covenant not to compete to protect against the seller opening a competing business.

Tax Implications of an Asset Sale for Financial Advisory and Planning Firms

Financial advisory practice sales are based on the transfer of individual assets, with the purchase price representing the value of those assets. In order to arrive at a value, a formal business valuation is contracted from a third party. Salomon explains that the buyer and seller must also agree to the allocation of value among the assets, which are then recorded on IRS Form 8954 and included in each party’s tax returns for that year. Each asset class is treated differently from an income tax perspective.

For the buyer, the tax considerations of each asset type are:

1. Fixed Assets: Such as office equipment and furniture. These can generally be written off in the year of purchase with IRS Section 179 or Bonus depreciation (which, used to exclude the purchase of used assets until the latest change in the tax law). Alternatively, the deduction can be taken over a 5 – 7 years, depending on the type of asset.
2. Intangible assets: Applicable to goodwill and covenants not to compete. These assets are considered to be Section 197 intangible assets and amortized over 15 years.

For the Seller, the tax implications for the goodwill are treated as capital gains, however, ordinary income is taxed on the receipt of funds for a covenant not to compete. Additional ordinary income taxation is possible for the recapture of prior depreciation.

Consulting Agreements to Support Client Transition After a Sale

In order to improve the transition of clients and ownership of the relationship, many transactions include an agreement to retain the services of the seller for a specific period of time. Salomon states that those agreements are generally restricted to 1-3 years. He also adds that “consulting agreements are tax deductible to the buyer in the year the fees are paid. They are taxed as ordinary income to the recipient, in addition to having to pay self-employment tax on the amount received.

Seller Financing and Payment Structures in Financial Advisory Practice Sales

If the buyer is making payments to the seller over time, Salomon says they must include interest. The interest paid is tax deductible to the buyer and “should be considered as taxable income to the seller at ordinary income tax rates.”

Below we have a chart which breaks down the key elements of a transaction and the tax implications for each the buyer and the seller.