A signed letter of intent usually has one number everyone remembers: the purchase price. What it does not settle is how that price gets divided across the categories the IRS cares about, and that division, not the headline number, is what decides how much of the sale is taxed as capital gain, how much as ordinary income, and how much shows up on next year's return in ways the seller did not expect.
This article is an educational overview of purchase price allocation for owners preparing to sell a business. It does not provide tax, legal, or accounting advice, and it does not recommend any specific allocation approach. Every allocation decision should be reviewed with a CPA and attorney who know the details of your transaction.
Photo by Nataliya Vaitkevich on Pexels
Why the Number in the Letter of Intent Isn't the Whole Story
Buyers and sellers negotiate a purchase price, but the IRS taxes an allocation, not a headline figure. Once the deal closes, both parties are required to file a version of the same form describing how the price was split across a defined list of asset classes: cash, securities, accounts receivable, inventory, equipment, real property, intangibles, goodwill, and a few other categories.
The split matters because different asset classes are taxed differently on the seller's side and depreciated or amortized differently on the buyer's side. A dollar allocated to inventory is treated differently than a dollar allocated to goodwill, and a dollar allocated to a covenant not to compete is treated differently still. The purchase agreement usually leaves room to negotiate this after the headline price is set, sometimes in a separate schedule finalized closer to closing.
A topic worth raising early with your CPA: whether the letter of intent already implies an allocation approach, even informally, and whether that approach is one your advisor would recommend defending on your own return.
The IRS Asset Classes Behind the Allocation Form
The IRS groups sale assets into seven classes for allocation purposes, generally described from most liquid to least. Cash and cash equivalents sit at one end. Actively traded securities and certificates of deposit come next. Accounts receivable and other debt instruments follow. Inventory held for sale to customers is its own class. Furniture, fixtures, vehicles, equipment, and real property make up another class. A residual class covers intangible assets other than goodwill, such as customer lists, patents, and licenses. Goodwill and going concern value make up the final class, and it absorbs whatever value is left once the other classes are filled.
The IRS publishes the governing form and instructions, and a topic worth reviewing with your CPA is how each class in your specific sale gets populated, since the classes are filled in order and the last class (goodwill) is where the most negotiation typically happens.
Photo by Muhtelifane on Pexels
Why Buyers and Sellers Often Want Different Allocations
Buyers and sellers frequently have opposite preferences for the same dollar. A buyer generally prefers more of the price allocated to assets that can be depreciated or amortized quickly, since that creates a faster tax deduction going forward. Equipment, short-lived intangibles, and covenants not to compete often fall into this category from the buyer's perspective.
Sellers generally prefer more of the price allocated to goodwill or to the sale of capital assets, since that portion is more likely to be taxed at capital gains rates rather than ordinary income rates. A covenant not to compete, for example, is typically taxed to the seller as ordinary income, while goodwill attributable to the business itself is more often taxed at capital gains rates.
This tension is a normal part of negotiating the allocation schedule, and it is one reason the schedule sometimes takes longer to finalize than the headline price. A topic to raise with your tax advisor: which classes in your deal carry the largest tax rate difference between ordinary income and capital gains treatment, since that is usually where the negotiation concentrates.
Goodwill, Personal Goodwill, and Non-Compete Payments
Goodwill itself can be split further in some transactions, between goodwill that belongs to the business entity and goodwill that belongs to the individual owner personally, sometimes called personal goodwill. The distinction has mattered in specific circumstances involving an owner's personal relationships, reputation, or expertise that a buyer is separately compensating for, apart from the entity's assets.
The concept is discussed at a general level in the Wikipedia entry on purchase price allocation, which is a reasonable starting point for understanding the framework before a substantive conversation with your CPA. Whether personal goodwill applies to a given transaction, and how much value it can reasonably support, is a fact-specific question that depends on the structure of the deal, the seller's role going forward, and prior case history in the relevant jurisdiction.
A related topic: how any post-closing consulting or non-compete agreement is priced and allocated separately from the entity sale itself, since these payments typically follow their own tax treatment and are negotiated as a distinct line item.
Photo by Sergey Meshkov on Pexels
Coordinating the Allocation Conversation With Your CPA and Attorney
The allocation schedule is usually drafted by the buyer's counsel or accountant first, since the buyer has an incentive to move quickly toward a preferred structure. That draft is a starting point for negotiation, not a final answer, and reviewing it independently before signing is one of the more consequential steps in the closing process.
Topics worth raising with your own CPA before you respond to a draft allocation: how the proposed classes compare to what a seller in a similar transaction would typically request, what the estimated tax difference is between the buyer's proposal and an alternative allocation, and what supporting documentation (appraisals, valuation reports, prior agreements) would be needed to defend the numbers if the return were ever questioned.
Your transaction attorney should also review how the allocation schedule interacts with representations and warranties in the purchase agreement, since inconsistencies between the legal document and the tax filing can create problems well after closing. Professional standards for this kind of engagement are documented by organizations like the American Institute of CPAs, which maintains guidance for accountants working on transaction-related engagements.
Photo by Khaya Motsa on Pexels
Timing: When the Allocation Conversation Should Start
A common pattern in smaller business sales is that the allocation schedule does not get serious attention until a few weeks before closing, once the purchase agreement is mostly finalized and the buyer's accountant sends over a proposed Form 8594 draft for review. By that point, the seller's negotiating leverage over the allocation is often lower than it would have been earlier, since the broader deal terms are already locked.
Raising the allocation topic earlier, even in general terms during the letter of intent stage, gives your CPA more room to model the tax impact of different scenarios before the purchase agreement language is finalized. This is particularly relevant when a meaningful part of the price is likely to be attributed to a non-compete or consulting arrangement, since those terms often get negotiated as part of the broader deal structure rather than as an afterthought.
A topic worth raising with your transaction advisor at the letter of intent stage: whether it makes sense to include a general allocation framework, or at least an agreement to negotiate the schedule in good faith using specified principles, directly in the letter of intent itself, rather than leaving the entire conversation for later.
Verifying the Advisors in the Room
A purchase price allocation touches tax law, valuation methodology, and deal structuring at the same time, which is a combination that not every general practice CPA or attorney handles regularly. Before the allocation conversation gets underway, it is worth confirming that the professionals advising you have handled transactions of a similar size and structure before.
For financial advisors specifically, credentials and disciplinary history can be checked through FINRA BrokerCheck and through membership directories maintained by organizations like the National Association of Personal Financial Advisors. Capivise's own advisor verification resource covers a broader checklist for confirming an advisor's background before a transaction of this size, and Capivise's questions to ask an advisor framework covers the kinds of questions worth asking before you engage anyone for deal-related work.
Questions Worth Raising Before You Sign the Allocation Schedule
A short list of topics worth bringing to your own CPA and attorney before finalizing the allocation, rather than after:
- How does the proposed allocation compare, class by class, to typical practice for a business of this size and industry?
- What documentation exists to support the values assigned to intangibles and goodwill if the allocation is ever examined?
- How is any non-compete or consulting payment priced, and is that price reasonable relative to the services or restriction involved?
- Does the allocation schedule match the language already in the signed purchase agreement, or does it introduce a new structure?
- What is the estimated total tax difference between the buyer's initial proposal and the alternative your own advisor would recommend defending?
None of these questions have a single correct answer that applies across transactions. They are a starting point for a conversation with professionals who can evaluate your specific facts.
Closing Thought
Purchase price allocation rarely gets attention during the emotional high point of agreeing to a headline price, but it is one of the last opportunities to influence how much of that price the seller actually keeps. Working through the allocation schedule with a coordinated CPA and attorney, well before the closing date, is time well spent.
For owners still assembling that advisor team, Capivise is built around helping people find and verify advisors experienced with transactions like this one, and the business sale advisor resource covers the broader set of topics worth addressing before a sale closes, not just the allocation schedule itself.
