7 Tax Issues to Consider When Selling a Financial Advisory Firm

By Aimee Jachym

Selling a financial advisory firm is a significant decision that involves numerous considerations, particularly regarding tax implications. As a financial advisor, understanding these tax issues is crucial to ensure a smooth transition and maximize the financial benefits of the sale. Here are seven key tax issues to consider:

1. Deal Structure: Asset Sale vs. Equity Sale

The structure of the deal can significantly impact the tax treatment of the transaction. There are generally two ways to structure the sale of a financial advisory firm: an asset sale or an equity sale. Most financial advisory firm transactions are structured as asset sales. 

Asset Sale: In an asset sale, individual assets of the firm are sold. This approach often involves selling goodwill, client lists, and other intangible assets, as financial advisory firms typically have few fixed assets. The buyer can benefit from depreciating these assets over time but the seller may face higher tax rates than in an equity sale.

Equity Sale: In an equity sale, the buyer purchases the seller’s ownership interest in the firm. This method can be more tax-efficient for the seller but buyers generally avoid equity sales due to the potential for inheriting unknown liabilities.

2. Existing Firm Tax Structure

Financial advisory firms are usually structured in one of three ways: C corporations, S corporations, or partnerships. The existing tax structure of a firm will affect how a sale transaction is handled, depending on whether it is an asset or equity sale.

3. Allocation of Purchase Price

Both the buyer and seller must agree on an allocation of purchase price, which is then reported to the IRS by both of them. Proper allocation can help minimize the overall tax burden for sellers. For example, allocating more of the purchase price to goodwill (taxed at capital gains rates) rather than to ordinary income assets (such as restrictive covenants) can be beneficial for the seller.

4. Restrictive Covenants

Covenants not to compete, non-solicitation provisions, and other restrictive covenants are customary in the transaction agreement. These protect the buyer from competition by the seller post-sale. The tax treatment of payments for non-compete agreements can vary. These payments are often taxed as ordinary income, which can increase the seller’s tax burden.

5. State and Local Taxes

State and local taxes can affect the net proceeds from the sale. Each state has its own tax rates and rules regarding the sale of business assets, as do some local jurisdictions. Consulting with a tax professional who understands the local tax landscape in your area is essential to navigate these complexities.

6. Retirement Plans and Deferred Compensation

If the firm has retirement plans or deferred compensation arrangements, these must be addressed in the sale. The treatment of these plans can have tax implications for both the buyer and the seller. Ensuring these plans are handled correctly can prevent unexpected tax liabilities.

7. Consulting with Legal and Tax Professionals

Given the complexity of tax issues involved in selling a financial advisory firm, it is crucial to consult with legal and tax professionals who specialize in this area. They can provide tailored advice and help structure the deal to minimize tax liabilities and maximize financial outcomes.

Conclusion

Selling a financial advisory firm involves navigating a myriad of tax issues that can significantly impact the financial outcome of the transaction. By understanding the implications of these issues, financial advisors can better prepare for a successful sale. Consulting with legal and tax professionals is essential to ensure that all aspects of the transaction are handled in a tax-efficient and legal manner.

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Aimee J. Jachym is a member in Miller Johnson's Corporate and Mergers & Acquisition practice representing businesses in commercial transactions.

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