Choosing the Right Tax Structure for Selling a Business
If you are considering selling your business sometime in the not-too-distant future, one issue that will most certainly factor into the transaction is taxes. Since most business owners have never been through the process of selling their company in the past, this is usually one of those great unknowns, and it can be a very costly one if it is not effectively addressed ahead of time.
For privately owned businesses, the amount that is paid in taxes often represents the largest expense that is paid after a sale. Paying some tax is unavoidable, but there are strategies you can adopt to help ensure that your tax burden is minimized.
There are a lot of variables that factor into what your tax situation will look like after the business sale is complete. Some of the most important include:
- Your entity structure; are you operating as a sole proprietorship, partnership, limited liability company (LLC), or corporation?
- How much of the sale price is being used to purchase tangible assets (such as real estate property, computers, equipment, etc.), and how much is going toward the purchase of intangible assets (such as trade secrets and goodwill)?
- Will the proceeds from your sale be considered ordinary income or capital gains?
- Are you willing to take installment payments over time, or do you want to receive all of your funds at once?
Before coming up with a strategy to address your tax situation during a business sale, it is important to know what your goals are. Of course, the primary goal of a business owner is to maximize profits from a sale. But what comes next? And what do you plan to do with the proceeds from the sale?
Some sellers are going straight into retirement, while others might need funds to help take care of an ailing loved one. Many business owners also would like to allocate some the funds from the sale to help their favorite charity. By knowing what you want to do with the money, you will be better able to plan your tax strategy.
Much of this goes back to the previous question about taking installments versus a lump sum payment for your business. If you do not need all of the money right away, an installment sale can save you a significant amount of money in taxes. Since the proceeds are deferred, you will not have to pay tax on it until they are received.
There are other factors to consider with an installment sale, however, such as the credit worthiness of the buyer and their ability to pay. This, of course, will depend heavily on the future success (or failure) of the business. Another important issue is that not all assets are eligible for an installment sale. This can only be done on assets in which you will pay capital gains taxes rather than ordinary income taxes.
Selling a Corporation: Asset Sale vs. Stock Sale: If you are selling a corporation, it is important to realize that you may be in for a difficult negotiation with the buyer. The reason is that as a seller, it is preferable to sell shares of stock, rather than assets. The reason is simple; double taxation.
With an asset sale, you will first have to pay taxes on all of the income you make from the sale of the assets, then you will also pay capital gains taxes as a shareholder after your corporation is liquidated. With a stock sale, all you pay is the long-term capital gains rate, which is a much better situation for you.
Things are different for the buyer, however. Buyers will normally prefer an asset sale, because their basis for depreciation will be the allocated purchase price of the transferred asset. With a stock sale, the basis is whatever it was when the seller purchased the asset. And if the seller already took full depreciation on it, the buyer would not be able to depreciate the asset.
At the end of the day, a stock sale is usually best for the combined tax situations of both the seller and the buyer, and the seller can often use this fact as leverage to adjust the sale price (with a stock sale) in order to make it fair for both parties.
Another potential way to address this issue is to change your company from a C corporation to an S corporation. With an S corporation, the seller would only pay capital gains taxes regardless of whether it was an asset or stock sale. This eliminates the double taxation issue.
Building a Professional Business Sales Team: When it comes to taxes during a business sale, there are a lot of things to consider. This is one of many reasons that it is important to assemble a team of professionals to assist you with this transaction. Two essential members of the team will be a tax professional who can help you with putting together the right tax strategy, and a business intermediary.
Business intermediaries, also known as business brokers, have extensive experience handling business sales transactions, and they can work closely with you to help you successfully navigate the complexities of this process and ensure that you are able to sell your business for maximum value.