Purchase Price Allocation - The Hidden Tax Battle in M&A Deals

You just agreed to sell your business for $8 million. The champagne is chilling, and you’re already calculating what you’ll net after taxes. But here’s what your buyer’s accountant knows that you might not: how that $8 million gets divided across asset categories can significantly influence your total tax bill, potentially by hundreds of thousands of dollars depending on your specific circumstances, basis in assets, and applicable tax rates.

Executive Summary

Purchase price allocation represents one of the most consequential yet frequently overlooked negotiations in M&A transactions. When a buyer acquires a business, the total purchase price must be allocated across specific asset categories: goodwill, equipment, inventory, accounts receivable, and covenants not to compete. Each carries dramatically different tax implications for both parties.

For sellers, this allocation influences whether proceeds receive favorable long-term capital gains treatment or less favorable ordinary income treatment. Under current federal tax law (IRC Sections 1 and 1(h)), long-term capital gains face a maximum rate of 20%, while ordinary income can reach 37% for high earners. That’s a 17 percentage point differential that compounds across substantial allocation amounts. For buyers, allocation affects depreciation schedules and the speed at which they can recover their investment through tax deductions. These opposing interests create a negotiation where allocation percentages themselves may represent significant economic value entirely separate from the headline purchase price.

We regularly see sellers who negotiate purchase price aggressively but accept allocation terms without understanding their impact. The result can be tax bills that surprise them after closing, potentially eroding some of the premium they thought they achieved. This article examines the specific tax treatment of each allocation category, identifies common negotiation positions and their economic rationale, and provides frameworks for protecting your after-tax proceeds while maintaining deal balance. Understanding purchase price allocation positions you to engage more effectively in these negotiations, though your leverage will depend significantly on market conditions and deal dynamics. Individual circumstances vary considerably, and professional tax guidance remains necessary for any specific transaction.

Introduction

The moment your business sale closes, your accountant faces a critical task: calculating taxes owed based not on what you sold but on how the purchase price was allocated across asset categories in your definitive agreement. This allocation, often negotiated as an afterthought or accepted from buyer-proposed terms, influences whether most of your proceeds qualify for favorable capital gains rates or get characterized as ordinary income taxed at significantly higher rates.

Purchase price allocation exists because the IRS requires buyers and sellers to agree on how transaction proceeds correspond to specific asset values. This requirement, governed primarily by IRC Section 1060 and the residual method outlined in Treasury Regulation 1.1060-1, prevents parties from taking inconsistent positions that would allow both to claim favorable treatment. The buyer’s allocation becomes the seller’s allocation, binding both parties to the same characterization of what was purchased and sold.

What makes purchase price allocation particularly consequential is the often opposing nature of the tax dynamics. Generally speaking, dollars a buyer allocates to quickly depreciable assets like equipment may represent dollars the seller must recognize at ordinary income rates, depending on the seller’s basis and depreciation history. Dollars allocated to goodwill typically give the seller favorable capital gains treatment but require the buyer to use 15-year amortization schedules. This opposition of interests means allocation negotiations can represent real economic stakes where gains for one party may come at the other’s expense.

Yet most sellers enter these negotiations unprepared. They’ve focused energy on purchase price, working capital adjustments, representations and warranties, and escrow terms. Allocation gets relegated to a schedule attached to the asset purchase agreement, often proposed by the buyer and accepted without meaningful negotiation. By the time sellers understand the implications, typically when preparing their first post-sale tax return, the opportunity to negotiate has passed.

Based on our experience advising clients through M&A transactions, we’ve observed allocation differences that created meaningful variation in after-tax proceeds on transactions across the lower middle market. While outcomes depend heavily on individual circumstances (including seller basis in assets, state tax treatment, and overall income situation), the potential for substantial tax impact on deals in the $3-10 million range is real. Understanding purchase price allocation represents important preparation for negotiations that can influence what you actually keep from your life’s work.

The Allocation Categories and Their Tax Treatment

Purchase price allocation follows a hierarchy established by IRS regulations under the residual method, dividing transaction proceeds across seven asset classes. For most business sales in the lower middle market, four categories capture the vast majority of allocated value, each with distinct tax implications for sellers.

Goodwill and Going Concern Value - Class VII Assets

Goodwill represents the premium buyers pay above the fair market value of identifiable tangible and intangible assets. It reflects customer relationships, brand reputation, market position, and the earnings capacity that makes the business worth more than its parts. For sellers, goodwill allocation is typically the most favorable outcome: proceeds allocated to goodwill generally receive long-term capital gains treatment.

Under current federal tax law (IRC Section 1(h)), long-term capital gains face a maximum rate of 20%, plus the 3.8% net investment income tax (IRC Section 1411) for taxpayers exceeding certain income thresholds. The capital gains treatment applies because goodwill meets the definition of a capital asset held long-term. Sellers have typically built this value over years or decades, and the tax code rewards patient capital formation with preferential rates.

To illustrate the potential impact with specific numbers: On a $5 million allocation to goodwill, a seller in the highest federal bracket (assuming the 3.8% NIIT applies and ignoring state taxes) would pay approximately $1.19 million in federal taxes ($5 million × 23.8%). The same $5 million characterized entirely as ordinary income would generate approximately $1.85 million in federal taxes ($5 million × 37%): a difference of roughly $660,000 from allocation characterization alone. This calculation assumes the seller has minimal basis in goodwill, which is typical since goodwill is usually self-created rather than purchased.

For buyers, goodwill presents the least attractive allocation from a tax timing perspective. IRC Section 197 requires goodwill amortization over 15 years on a straight-line basis, meaning buyers recover their investment slowly, roughly 6.67% per year in deductions. Buyers seeking to maximize near-term tax benefits often push to minimize goodwill allocation, creating direct tension with seller interests.

Tangible Personal Property - Class V Assets

Equipment, machinery, furniture, fixtures, and vehicles fall into Class V, where allocation can create depreciation recapture consequences for sellers. When you’ve depreciated an asset over its useful life, selling it for more than its depreciated basis triggers recapture of those depreciation deductions as ordinary income under IRC Section 1245.

Consider equipment you purchased for $500,000 and depreciated to a $50,000 book value. If allocation assigns $300,000 to this equipment, you would recognize $250,000 of depreciation recapture taxed as ordinary income at rates up to 37% federally, plus any gain above original cost potentially taxed at capital gains rates. The depreciation you claimed over years of ownership comes back as income in your sale year.

Buyers often favor equipment allocation because Section 179 expensing and bonus depreciation rules (currently under IRC Section 168(k), though subject to phase-down schedules) may allow rapid cost recovery. Depending on current tax law provisions and phase-out schedules, buyers may deduct significant equipment allocations immediately or over accelerated timeframes. This faster recovery makes equipment allocation valuable to buyers, potentially intensifying pressure on sellers to accept allocations that trigger recapture.

Inventory - Class IV Assets

Inventory allocation generates ordinary income for sellers in most circumstances. The gain on inventory sale (purchase price allocation minus cost basis) typically receives no capital gains benefit. Sellers generally pay ordinary income rates on inventory profits, making heavy inventory allocation among the less favorable outcomes for sellers.

Buyers maintain relative indifference to inventory allocation since they’ll expense inventory through cost of goods sold as products are resold. The allocation affects timing but not character of their deduction. This indifference sometimes creates negotiating opportunity: buyers may accept reduced inventory allocation without equivalent pushback on other categories.

For business owners with substantial inventory, pre-sale planning can potentially reduce exposure. Drawing down inventory levels before sale through normal business operations reduces the asset base subject to potentially unfavorable allocation. But this strategy carries operational risks: aggressive inventory reduction may impair business performance, reduce revenue during due diligence periods, or create working capital issues that affect deal valuation. We generally advise clients to discuss inventory optimization strategies with their M&A advisors 12-18 months before anticipated transactions, balancing tax considerations against operational realities.

Covenants Not to Compete - Separate Treatment

Non-compete agreements receive special treatment in purchase price allocation. Amounts allocated to covenants not to compete are generally taxed as ordinary income to sellers, typically recognized ratably across the payment or covenant period. A $500,000 five-year non-compete would generally generate $100,000 of ordinary income annually, taxed at rates up to 37% federally.

Buyers find non-compete allocation attractive because they can amortize non-compete payments over the agreement’s term under Section 197, which is often shorter than the 15 years required for goodwill. A five-year non-compete allows cost recovery twice as fast as goodwill amortization, providing more valuable near-term tax benefits.

The negotiating dynamic around non-competes can be particularly contentious because allocation to this category may directly convert potential seller capital gains to ordinary income. Each dollar shifted from goodwill to non-compete could cost sellers the rate differential, potentially 17 percentage points federally, on that allocation. A $300,000 non-compete allocation might cost sellers approximately $51,000 more in federal taxes compared to equivalent goodwill treatment ($300,000 × 17%), depending on their specific tax situation.

In our experience advising on transactions in the lower middle market, non-compete allocations typically fall in the 5-15% range of total consideration for deals with legitimate competitive concerns. This aligns with what we’ve seen from industry practitioners and valuation professionals. Allocations substantially above this range may draw IRS scrutiny if they lack economic substance supporting the valuation.

Illustrating the Tax Impact - A Detailed Example

To demonstrate how purchase price allocation can create meaningful tax differences, consider this detailed example with specific assumptions:

Transaction Details:

• Sale price: $8 million
• Seller’s total basis in assets: $1.5 million
• Seller’s federal tax bracket: Highest marginal rates (37% ordinary income, 20% capital gains plus 3.8% NIIT)
• State taxes: Excluded for simplicity

Scenario A - Seller-Favorable Allocation:

Scenario B - Buyer-Favorable Allocation:

Tax Difference: $264,000

This example shows several key points. First, the same $8 million purchase price produces $264,000 different tax outcomes based solely on allocation—and this assumes relatively moderate allocation differences. More aggressive buyer positions could widen this gap further. Second, the impact scales with transaction size and the amount shifted between categories. Third, state taxes (which can add 5-13% in high-tax states) would amplify these differences.

For larger allocation shifts or sellers with different basis positions, the impact can exceed $500,000 on an $8 million transaction. Conversely, sellers with high basis in assets or those in lower tax brackets would see smaller differences. The critical point is that your specific circumstances, particularly your basis in each asset category, drive your actual tax exposure.

Asset Sales Versus Stock Sales - A Critical Distinction

Before diving deeper into allocation strategy, understand that purchase price allocation primarily applies to asset sales. The choice between asset and stock sale structure fundamentally changes the tax analysis.

When Purchase Price Allocation Applies

In an asset sale, the buyer acquires specific assets and assumes specific liabilities. The purchase price must be allocated across asset categories as described above, with each category receiving distinct tax treatment. Asset sales are common in the lower middle market, particularly for:

• Sales of sole proprietorships, partnerships, or LLCs taxed as partnerships
• Transactions where buyers want to limit liability exposure
• Deals where buyers specifically want a stepped-up tax basis in acquired assets
• S corporation sales (though with additional complexity around built-in gains)

Stock Sales - A Different Dynamic

In a stock sale, the buyer acquires ownership interests in the entity rather than individual assets. For sellers, stock sales often provide favorable treatment: the entire gain typically qualifies as long-term capital gains if the stock was held more than one year. There’s generally no depreciation recapture or ordinary income conversion concerns at the seller level.

But stock sales present challenges for buyers. The acquiring company inherits the target’s historical tax basis in assets—no step-up occurs. This means buyers cannot claim the enhanced depreciation and amortization deductions they’d receive in an asset sale. The net present value difference can be substantial, often leading buyers to prefer asset purchases or to request significant price adjustments for stock deals.

Before engaging in allocation negotiation, consider whether stock sale structure might achieve better overall economics despite buyer preference for asset purchases. In some cases, the simplicity of stock sale treatment and avoidance of allocation complexity may provide superior after-tax results, particularly for sellers with low basis stock.

Section 338(h)(10) Elections

For certain transactions involving S corporations or consolidated subsidiary corporations, buyers and sellers can jointly elect under IRC Section 338(h)(10) to treat a stock sale as an asset sale for tax purposes. This provides buyers with the stepped-up basis they want while maintaining stock sale mechanics. The allocation analysis then applies just as it would in an actual asset sale.

Understanding which transaction structure applies, and whether elections might change the applicable rules, is necessary before engaging in allocation negotiation.

The Zero-Sum Tax Dynamics Between Buyers and Sellers

Understanding why buyers and sellers often take opposing positions on purchase price allocation requires recognizing the asymmetry in tax treatment. This represents rational economic behavior driven by real tax consequences.

What Buyers Want and Why

Buyers typically seek allocations that maximize near-term tax deductions, reducing their after-tax cost of acquisition. Their priority hierarchy generally follows:

High priority for buyers: Inventory, accounts receivable, and short-lived assets that generate immediate deductions or rapid cost recovery. Equipment qualifying for bonus depreciation (where still available) provides accelerated deductions that reduce taxes in the acquisition year or shortly thereafter.

Medium priority: Covenants not to compete that amortize over five years or less, customer lists and similar intangibles that qualify for Section 197 treatment.

Low priority: Goodwill requiring 15-year straight-line amortization, providing the slowest cost recovery and least valuable near-term tax benefits.

Sophisticated buyers calculate the net present value of different allocation scenarios, determining how much they’d effectively pay for favorable allocation treatment. A buyer facing 15-year amortization on $2 million of goodwill might value immediate expensing of the same amount at $200,000-$400,000 depending on discount rates, cost of capital, and their specific tax situation.

What Sellers Want and Why

Sellers typically seek allocations that maximize capital gains treatment and minimize ordinary income recognition. Their priority hierarchy often directly opposes buyers:

High priority for sellers: Goodwill and going concern value taxed at long-term capital gains rates, representing the most favorable tax treatment generally available on business sale proceeds.

Medium priority: Assets without depreciation recapture exposure—real estate held long-term, intellectual property with minimal basis, and similar capital assets generating capital gains.

Low priority: Inventory generating ordinary income, equipment triggering depreciation recapture, and covenants not to compete characterized as ordinary income regardless of holding period.

This opposition creates a dynamic where allocation concessions by either party may transfer economic value to the other. Unlike many deal terms where creative structuring can create mutual benefit, allocation mathematics are relatively fixed once asset categories are determined.

The Information Asymmetry Challenge

Private equity buyers, strategic acquirers with active M&A programs, and their specialized tax advisors typically understand purchase price allocation deeply. They’ve negotiated dozens or hundreds of transactions, optimizing allocation terms across their portfolio. They often arrive at negotiations with allocation strategies, tax models, and negotiating approaches refined through experience.

First-time sellers frequently lack equivalent sophistication. Their regular accountants may be excellent at business tax compliance but less experienced in M&A transaction structuring. Their attorneys might be skilled in commercial transactions but less familiar with allocation economics. This asymmetry means buyer-proposed allocations may favor buyer interests substantially, sometimes presented as “standard” or “market” terms to sellers lacking context for evaluation.

This information gap shows why sellers benefit from engaging M-and-A-experienced tax advisors early in the process—professionals who can evaluate allocation proposals against market norms and quantify the economic impact of various positions.

State Tax Considerations - The Often-Overlooked Variable

Federal tax treatment drives most allocation analysis, but state tax consequences can significantly affect total tax liability and deserve careful consideration.

States Without Capital Gains Preference

Not all states offer preferential treatment for capital gains. States including California, New Jersey, and Minnesota generally tax capital gains as ordinary income at the state level. For sellers in these jurisdictions, the federal advantage of goodwill allocation remains, but the state-level benefit may be minimal or nonexistent.

States With Capital Gains Benefits

Other states offer various forms of capital gains preference. Some provide exclusions for certain percentages of capital gains, while others offer reduced rates. Understanding your state’s specific treatment is necessary for accurate tax modeling.

Residency Timing Considerations

Some sellers consider changing state residency before a transaction to take advantage of more favorable tax treatment. This strategy requires careful planning—states have varying rules about residency establishment, and the IRS scrutinizes residency changes made shortly before liquidity events. Moving from California to Nevada, for example, generally requires establishing genuine domicile in the new state, not merely maintaining a mailing address.

Impact on Allocation Strategy

State tax treatment should inform your allocation negotiation priorities. If you’re in a state that taxes capital gains as ordinary income, the federal benefit of goodwill allocation remains significant, but your total tax savings from favorable allocation may be somewhat less than for sellers in states with capital gains preferences. Your tax modeling should reflect your specific state situation.

Negotiation Frameworks for Protecting Seller Interests

Effective allocation negotiation requires preparation beginning well before term sheets are signed. Sellers who wait until definitive agreement drafting to consider allocation often find themselves responding to buyer proposals rather than advancing their own positions. But allocation optimization works best for larger transactions and situations where sellers have meaningful negotiating leverage. In competitive auctions, focus may be better placed on other deal terms.

Establish Independent Valuations Early

Before entering negotiations, consider obtaining independent appraisals of major asset categories from qualified valuation professionals. These appraisals establish defensible ranges for allocation positions and make it more difficult for buyers to claim extreme allocations represent “fair market value.”

Equipment appraisals document current market values for machinery and fixtures, often substantially different from book values that drive depreciation recapture calculations. Inventory assessments establish realistic values that may differ from accounting cost bases. Intangible asset valuations—customer relationships, trade names, proprietary processes—document the foundation for goodwill allocation.

Based on our experience with transactions in the lower middle market, these valuations typically cost $10,000-$50,000 depending on several factors: business size and complexity, number of asset categories requiring separate valuation, industry-specific considerations (regulated industries often require more detailed analysis), and the depth of documentation needed. A straightforward service business might fall toward the lower end, while a manufacturer with complex equipment, significant inventory, and multiple intangible assets would trend higher.

Independent appraisals provide professional support for allocation positions but don’t guarantee negotiating success. They transform subjective negotiation into documented positions with professional support, making buyer challenges more difficult and seller concessions more justified when strategically made. But appraisals can be challenged, and valuation ranges often overlap significantly between buyer and seller positions.

Link Allocation to Overall Deal Economics

Allocation doesn’t exist in isolation—it’s one component of total transaction economics. Sophisticated sellers negotiate allocation as part of the complete package, understanding that concessions on allocation might potentially be offset by benefits elsewhere.

If a buyer insists on $500,000 more equipment allocation than you consider defensible, that might be worth approximately $75,000-$85,000 in additional seller taxes at ordinary income rates versus capital gains (depending on your specific situation). You might consider accepting that allocation in exchange for higher purchase price, reduced escrow amounts, or improved indemnification terms. The key is quantifying allocation’s economic impact and trading value for value across deal terms.

This approach requires tax modeling before negotiations. Work with your M&A tax advisor to calculate after-tax proceeds under various allocation scenarios, understanding what each allocation position costs you in approximate terms. Armed with these numbers, you can make more rational tradeoffs rather than conceding allocation value for general goodwill.

Understand Full Transaction Costs

When evaluating allocation optimization strategies, consider the complete cost picture. Beyond appraisal fees, full allocation optimization typically involves:

• M&A attorney fees for allocation negotiation and documentation: $25,000-$75,000
• M&A tax advisor fees for modeling and strategy: $15,000-$40,000
• Owner time investment: 50-100+ hours over the transaction process

These costs come on top of your overall transaction advisory fees (investment banker fees, general legal fees, etc.). For a $5 million transaction, total professional fees related to allocation optimization might reach $75,000-$150,000 when including the incremental allocation-focused work. This investment makes sense when potential tax savings significantly exceed these costs—but may not be justified for smaller transactions or situations where negotiating leverage is limited.

Identify Defensible Boundaries

Some allocation positions stretch beyond legitimate negotiation into territory that invites IRS challenge. Allocating $2 million to a non-compete agreement when comparable market data might support $200,000 isn’t aggressive positioning—it’s potentially unjustifiable characterization that could create problems for both parties.

Establish reasonable boundaries for your negotiations:

Defensible non-compete values based on actual market data for comparable agreements, typically in the 5-15% range of total consideration for transactions with legitimate competitive concerns.

Equipment allocation not exceeding fair market value as documented by independent appraisal, regardless of depreciation recapture implications.

Goodwill allocation reflecting the genuine premium paid above tangible asset values—often representing the core reason your business is worth acquiring.

Communicating these parameters early—during letter of intent negotiations rather than definitive agreement drafting—establishes expectations and may help prevent late-stage conflicts that threaten closing.

Document Allocation Rationale Contemporaneously

IRS examination of allocation positions years after closing requires documentation created during the transaction. Build your defensive record by:

Maintaining appraisal reports with contemporaneous dates showing values assigned before or during negotiations.

Documenting negotiation positions through email and letter correspondence demonstrating arm’s-length bargaining between adverse parties.

Creating allocation schedules with supporting calculations showing how allocations relate to documented asset values.

Preserving expert opinions from tax advisors supporting your allocation positions as reasonable under applicable law.

This documentation helps protect against potential IRS reallocation years after closing, when memories have faded and transaction participants may be unavailable to support positions taken.

When Allocation Negotiation May Not Be Worth the Effort

While this article focuses on strategies for optimizing purchase price allocation, several scenarios can limit their effectiveness or make other strategies superior:

Competitive auction processes: When multiple buyers are bidding aggressively, sellers often have limited leverage to negotiate any terms, including allocation. In these situations, focusing on price and key deal terms may yield better results than allocation optimization.

Forced or urgent sales: If you’re facing health issues, partner disputes, or other circumstances requiring quick sale, the 12-18 month preparation timeline isn’t realistic. Resources may be better spent on accelerating the transaction than optimizing allocation.

Smaller transactions: For deals under $3 million, the cost of comprehensive allocation optimization (appraisals, specialized tax advice, negotiation time) may consume a significant portion of potential tax savings. A simpler approach with basic tax modeling may be more cost-effective.

Seller with minimal tax basis: If you started the business with minimal investment and haven’t taken significant distributions, a larger portion of proceeds represents gain regardless of allocation. The relative benefit of capital gains treatment remains, but absolute tax liability will be substantial.

Alternative minimum tax considerations: Depending on your overall tax situation, AMT calculations might reduce the benefit of certain allocation strategies.

Changes in tax law: Tax rates and rules change. Strategies based on current law may become more or less effective depending on future legislative changes.

Aggressive positions that don’t survive audit: Allocation positions lacking economic substance or proper documentation may be challenged and reallocated by the IRS, potentially creating penalties in addition to additional tax.

Understanding these limitations helps set realistic expectations about what allocation negotiation can achieve.

Failure Modes to Consider

Allocation negotiation, like any deal element, carries risks that deserve consideration:

Buyer walks away due to allocation disputes: In competitive markets where buyers have alternatives, aggressive allocation demands can jeopardize the transaction entirely. A lost deal means all the potential tax savings—and the sale itself—evaporate. Balance allocation optimization against deal completion risk.

Distraction from more important terms: First-time sellers sometimes focus disproportionately on allocation while underweighting price, structure, or risk terms that have greater economic impact. Keep allocation in perspective as one element of overall deal economics.

IRS challenge years later: Allocation positions that lack documentation or push beyond defensible ranges may face examination and reallocation, potentially creating additional tax, penalties, and interest years after you thought the transaction was complete.

Allocation negotiation should be balanced against deal completion risk and other deal terms. In competitive processes, aggressive allocation demands may jeopardize transaction completion entirely.

Actionable Takeaways

Model your specific tax situation before making allocation decisions. Before negotiations begin, work with your tax advisor to calculate estimated after-tax proceeds under buyer-favorable, seller-favorable, and compromise allocations. Your specific circumstances, particularly your basis in each asset category, drive your actual exposure. General rules of thumb cannot substitute for personalized analysis.

Understand when allocation optimization makes sense for your situation. Allocation optimization requires balancing potential tax savings against preparation costs and transaction timing. In competitive processes or forced sales, resources may be better focused on price negotiation and deal completion. For smaller transactions, simplified approaches may be more cost-effective.

Consider raising allocation during letter of intent negotiations. Establish general allocation frameworks before transaction momentum creates pressure to accept unfavorable terms. Don’t relegate this potentially significant issue to final documentation review when time pressure is greatest.

Build your professional team with allocation expertise. Make sure your transaction accountant and attorney have specific M&A allocation experience, not just general business expertise. Ask prospective advisors about their experience with allocation negotiations and request references from similar transactions.

Obtain independent appraisals where justified by transaction size. For transactions where potential allocation impact exceeds $100,000+, professional appraisals provide defensible documentation. For smaller deals, this investment may not be cost-effective.

Document allocation rationale contemporaneously. Create defensive records supporting your allocation positions against potential IRS challenge. Appraisals, negotiation correspondence, and expert opinions become valuable if allocation faces examination years later.

Balance allocation against overall deal economics. Understand the dollar value of allocation positions and consider trading value across deal terms. A purchase price increase that offsets allocation concessions may represent an optimal outcome in some circumstances.

Conclusion

Purchase price allocation represents a consequential but often overlooked element of M&A transactions—one where sophisticated buyers have historically held advantages over first-time sellers. The stakes can be meaningful: allocation influences whether your proceeds face preferential capital gains rates or higher ordinary income treatment, potentially creating six-figure differences in after-tax proceeds on transactions of moderate size when allocation shifts involve substantial amounts and sellers have low basis in affected assets.

Yet allocation isn’t a mysterious domain reserved for tax specialists. The core concepts are accessible: goodwill generally provides favorable treatment for sellers, equipment and inventory may create ordinary income exposure, and non-compete allocations can convert potential capital gains to ordinary income. Understanding these dynamics positions you to engage more effectively in allocation negotiations rather than passively accepting buyer proposals, though your actual leverage will depend on market conditions and deal dynamics.

The time to prepare for allocation negotiation is before term sheets arrive and transaction momentum builds. Evaluate your asset mix, consider obtaining professional appraisals where justified, model your tax consequences with qualified advisors, and assemble a transaction team with allocation experience. Enter negotiations understanding what’s at stake in allocation discussions and how different positions affect your after-tax outcome.

Your headline purchase price matters, but your purchase price allocation influences what you actually keep. That distinction, between gross price and net proceeds, deserves careful attention as part of your overall exit strategy. With proper preparation, professional guidance, and realistic expectations about negotiating leverage, you can navigate allocation discussions as an informed participant working to protect your interests in this consequential element of your transaction.