When owners are looking to sell their businesses, they need to consider the impact of taxes on the sale. Savvy business owners can work with their investment bankers and CPAs to decrease or postpone the tax burden until later years, when the former owner may be in a lower tax bracket. Read this article to understand the tax strategies that you should consider as a business owner when selling your business.
Tax Strategies for Selling Your Business
- The key consideration for sole proprietors is the preferential tax treatment of long-term capital gains versus oridnary income rates. The IRS specifies seven asset types in a sale to which the seller and buyer must assign a percentage of the sales price. Negotiation is essential because not all asset classes are treated equally when it comes to taxation. The seller wishes to allocate as much as possible to asset classes such as goodwill, which is capitalized. The buyer, on the other hand, wishes to optimize the allocation of the selling price to asset classes such as real estate or equipment to depreciate them later. The final class i.e. Class VII is for goodwill and going concern value. This is the intangible asset that accounts for a portion of the purchase price. The bigger the business’s goodwill, the greater the allocation to this class, which is often beneficial to the seller because it is treated as the more favorable capital gain – not ordinary income.
- If you own an organization, you can structure the deal as a stock or asset sale. The selling of stocks is often a securities transaction involving a FINRA broker/dealer such as Bridge Capital Associates, Inc. Again, the buyer and seller’s agreement on how to structure the deal can have a substantial impact on the owner’s tax liability. An all-stock deal has the advantage of being treated as capital gains. An asset sale gives the buyer a higher basis in the company, allowing for future depreciation. In terms of gain, C-corporations and S-corporations are considered slightly differently. The 3.8% Medicare tax on net investment income is avoided by the latter form of corporation.
- To decrease the current tax bite, business owners may consider an installment sale. Another alternative is to sell a C-corporation to current employees via an employee stock ownership plan (ESOP). In that case, the seller receives cash from the ESOP and subsequently transfers it to a diversified portfolio to defer gains.
- Owners who earn capital gains on the sale of their business have another option to defer tax on that gain if they act within 180 days of the sale. They have the option of reinvesting their profits in an Opportunity Zone. Deferral is limited because gain must be recorded on December 31, 2026, or earlier if the interest in the investment is disposed of before that date. A business owner who sells his or her company is not required to place all the earnings into an Opportunity Zone, although tax deferral is limited as a result.
From a legal and tax standpoint, the selling of a business is an extremely complex process. Do not continue without competent guidance, and collaborate with a broker/dealer and investment banker who are knowledgeable in deal structuring. The amount of taxes you may have to pay may be dramatically affected. Bridge Capital’s associates have decades of combined investment banking expertise. Get in touch with us today for more information.