1099 and Consulting

[cpabsd]

A client purchased a business that was owner financed.  Part of the total purchase price included $345k allocated to consulting during the transition period.  What amount should be put on the 1099 as Non employee comp?  

Goodwill/client list       1,840,000

Furniture                          69,000

Non compete                   46,000

Consulting                        345,000

Total sale                                    2,300,000

$115,000 was paid as a down payment with the remainder being the owner financed  - $42000 paid on principal during the year.  

If the 1099 is not for the full $345,000, how would i possibly determine the amount it is for?  Or can I allocate the $345,000 over life of seller employment agreement for new owners which is 4 years?  

Thank you for any guidance.  

Bonnie

 

[Lee B]

So you are saying that the seller received the $115,000 down payment, $42,000 in principal plus interest payments in the first year.

The seller did not receive any additional consulting related payments in the first year?

 

[mircpa]

@cpabsd

What is transition period ? You mean from the time contract entered into until it is closed ?

[jklcpa]

Seller and purchaser should both be filing form 8594 with the returns that document the sale, and those must agree. The sales I've been involved with, one accountant prepared the form and sent to the other party for review, acceptance, and inclusion on their return.

Remember that any items in the sale that are ordinary income are reported in the year of sale and are not eligible for installment sale reporting.

[DANRVAN]

6 hours ago, jklcpa said:

any items in the sale that are ordinary income are reported in the year of sale and are not eligible for installment sale reporting.

I believe there is some confusion in that statement.

I am not aware of any reference to "ordinary income" in section 453.

In regards to depreciation recapture, 453(i)(1)(B) basically states that any gain in excess of recapture income shall be treated as installment sale income.

Also, there is not any reference given in the exceptions listed in 453(b)(2).

[DANRVAN]

8 hours ago, cpabsd said:

If the 1099 is not for the full $345,000, how would i possibly determine the amount it is for?

The consulting fee is a service deductible by the buyer when paid and taxable to the seller when received.

Per the agreement, it appears 15% of each payment will be allocated to the consulting fee.

This is a buyer friendly part of the agreement.  Unlike the Goodwill which is amortized over 15 years.

8 hours ago, cpabsd said:

$115,000 was paid as a down payment with the remainder being the owner financed  - $42000 paid on principal during the year.  

1099 amount for the year is $23,550 by my math.

8 hours ago, cpabsd said:

Goodwill/client list       1,840,000

Furniture                          69,000

Non compete                   46,000

Consulting                        345,000

allocated: 80%, 3% ,2%, and 15% 

[cpabsd]

The seller is not receiving the consulting income as a separate payment... it is incorporated into the total loan payment in the  seller financed loan from the buyer.  I know the Form 8594 is to be filed and they agreed to those amounts in the final contract.  This question is how to allocate the consulting portion of the loan payment.... or is that even an option?  The buyer is my client.  From my perspective, the buyer owns everything as of the date of the sale so they can begin depreciation /amortization right away.  Should the consulting amount be categorized as a prepayment of services and then recognized each year for the amount paid within the loan amount?  The seller has a four year employment commitment as part of the sales contract.  

[Lee B]

 Given the way the contract is written and the payment is structured, I agree with DANRVAN's analysis.

It will be interesting to see how the seller and their accountant react.

[kathyc2]

What is the legal structure of the company they purchased the assets from?  SP? Scorp? LLC?  

Are the payments made to a business or a person?

[DANRVAN]

3 hours ago, cpabsd said:

Should the consulting amount be categorized as a prepayment of services

Yes it needs to be booked.

 

17 hours ago, cpabsd said:

Or can I allocate the $345,000 over life of seller employment agreement for new owners which is 4 years?  

I suppose that could be an option, but if the life of the loan is also 4 years with equal payments it should work out about the same.

The issue I see in this whole deal is if the seller is actually providing a service?  Otherwise, it could be reclassified as Goodwill by the IRS and subject to 15 year amortization instead of a short write off.

1 hour ago, Lee B said:

t will be interesting to see how the seller and their accountant react.

I wonder what kind of tax advice the seller received on this which resulted in $345,000 in SE income.  But with a $2 million plus gain it might not mean much.  Maybe he will max out from other sources.

[Medlin Software, Dennis]

Hopefully at least one of the parties had proper representation. Sounds like no for both, or there would have been documentation to already spell this out.

[DANRVAN]

16 hours ago, cpabsd said:

From my perspective, the buyer owns everything as of the date of the sale

And after giving it more thought I am changing my initial answer.

Part of the note was used to purchase the Consulting fees so they need to be booked as a prepaid expense.   Then I would recognize them over the life of the agreement rather than an allocation of the principal.