The Tax Implications of Goodwill in Ohio Business Acquisitions

One key financial consideration when buying or selling a business is how goodwill is treated for tax purposes. Goodwill represents the premium paid for a business beyond its tangible assets, often reflecting brand reputation, customer loyalty, and operational efficiencies. While goodwill can provide tax benefits, it also comes with potential liabilities, making it an essential component of tax planning in acquisitions. This article explores the tax implications of goodwill for buyers and sellers in Ohio.

What is Goodwill in a Business Acquisition?

Goodwill is an intangible asset that arises when a business is purchased for more than the fair market value of its identifiable assets. It is the value attributed to a company’s brand, reputation, customer base, and overall market presence. Goodwill is only recognized in a business sale and cannot be recorded as an asset unless acquired.

For tax purposes, goodwill falls under Section 197 intangibles, including customer lists, trademarks, and other non-physical business assets. Unlike tangible assets, goodwill does not depreciate but is amortized over time under IRS rules.

Tax Treatment for Buyers: Amortizing Goodwill

For buyers, goodwill is a capital asset that must be amortized over 15 years (180 months) on a straight-line basis, according to Internal Revenue Code (IRC) Section 197. This means the total amount allocated to goodwill is spread evenly over 15 years, beginning with the month the intangible was acquired. This provides annual tax deductions that reduce taxable income.

Example of Goodwill Amortization

  • If a buyer allocates $1.5 million to goodwill in an acquisition, they can deduct $100,000 per year ($1.5M ÷ 15 years).
  • If the buyer is a corporation subject to the 21% corporate tax rate, this deduction results in an annual tax savings of $21,000.

This amortization provides a significant tax advantage, improving after-tax cash flow and making acquisitions more financially attractive.

Reporting Requirements

Buyers and sellers must report the agreed-upon allocation of goodwill and other assets to the IRS using Form 8594 (Asset Acquisition Statement) under Section 1060. Both parties must use the same allocation, ensuring consistency in tax filings to avoid IRS scrutiny.

Tax Treatment for Sellers: Capital Gains and Recapture

For sellers, the taxation of goodwill depends on how the sale is structured:

  1. Goodwill is Generally Taxed as a Long-Term Capital Gain

  • If the goodwill has been owned for over one year, the gain on its sale is usually subject to long-term capital gains tax rates (0%, 15%, or 20%, depending on income level).
  • Capital gains rates are lower than ordinary income tax rates, making goodwill a tax-favorable portion of the sale proceeds.

  1. Depreciation Recapture Can Trigger Ordinary Income Tax

  • If the seller previously amortized goodwill under Section 197, the IRS requires recapturing that portion as ordinary income rather than capital gain.
  • Example: If a seller claimed $500,000 in amortization deductions over several years and sold the goodwill, the first $500,000 of gain would be taxed as ordinary income, while any additional gain would be taxed at capital gains rates.

  1. Personal Goodwill Tax Strategy

In some cases, business owners can classify goodwill as personal goodwill, which belongs to the individual rather than the company. This is especially relevant in businesses where the owner’s relationships drive value (e.g., consulting firms, law firms). Personal goodwill is taxed only once at capital gains rates and avoids double taxation in C-corporation sales.

Tax Benefits and Liabilities of Goodwill

Benefits of Goodwill in Business Acquisitions

  • For buyers: Goodwill provides tax deductions via 15-year amortization.
  • For sellers: Goodwill is usually taxed at the lower capital gains rate instead of ordinary income.
  • For tax planning: Buyers and sellers can negotiate purchase price allocations to optimize tax outcomes.

Liabilities and Considerations

  • Depreciation recapture: If previously amortized, part of the gain on goodwill may be taxed as ordinary income.
  • Double taxation for C-Corps: C-corporations selling goodwill face corporate tax + dividend tax, reducing net proceeds.
  • Anti-churning rules: IRS rules prevent related parties from artificially reclassifying non-amortizable goodwill into amortizable goodwill.

Recent Regulatory Changes and Considerations

As of the 2024 tax year, the 15-year amortization rule for goodwill remains unchanged under IRS Section 197. However, your tax professionals stay updated on proposed legislation that might alter depreciation rules or capital gains rates.

Article Key Takeaways:

  • Goodwill remains amortizable over 15 years for buyers.
  • Sellers benefit from capital gains tax treatment, but prior amortization may trigger recapture as ordinary income.
  • Proper allocation of goodwill in a business sale is essential for tax optimization and IRS compliance.

If you’re buying or selling a business, working with a tax advisor can help structure the deal to maximize benefits and minimize tax liabilities associated with goodwill.

Navigating Goodwill in Business Sales

Understanding goodwill’s tax treatment can save you thousands in taxes. To maximize your financial advantage, consult with a tax professional before structuring your business sale or acquisition.

About This Central Ohio Acquisition Company

Expanders, Inc. acquires and operates privately held Central Ohio companies when their owners experience life-changing events or are ready to retire. The Expanders buy-grow-keep strategy entails investing in established businesses with significant potential for growth. This process of sustained growth compounds shareholder value over time.

They are interested in commercial and residential construction-related businesses, including builders, excavators, trenchers, remodelers, HVAC contractors, plumbers, electricians, roofers, paving companies, and hauling services.

If you want to start a conversation, see where the conversation may lead!