Are you thinking of selling your business? When selling a business, there is a lot to organize and prepare but an often-overlooked aspect of a business sale is taxes. Working with an experienced business broker can help but it doesn’t hurt to have an understanding of tax basics yourself.
When you sell your business, you’ll be bringing in some income and with income, comes taxes. How much of the profit goes to taxes and how much of it you get to keep can depend on how the sale is structured, the existing setup for the business, whether the sale is payment-based or cash, and much more.
Fundamentals of Selling Your Business
When you’re selling your business, you’ll have several decisions to make on the tax side. These will be dictated in some part by the buyer and the negotiations they make while others will be determined by the Internal Revenue Service (IRS) and the laws that are in place. The most important tax-related issues you need to consider when selling your business are:
· Will the proceeds from the sale be taxed as ordinary income or capital gains?
· Is the sale structured where it requires payment installments or is it all-cash?
· Is the sale an asset sale or a stock sale?
· In the case of a deal between two corporations, can the sale be treated as a tax-free merger?
There are additional considerations in some states where more or fewer taxes may be collected on the same deal. The above is based on the requirements of the IRS as it relates to federal income taxes. In all instances it is strongly recommended that both sellers and buyers consult with experienced tax CPA’s before entering into any type of sales agreement.
Will the proceeds from the sale be taxed as ordinary income or capital gains?
With rare exceptions, the IRS does not see the sale of a business as the sale of a single asset. The IRS sees it as the sale of all the business’s individual assets.
Knowing how a sale will be taxed can have distinctly unique tax implications. Profits that are treated as ordinary income will be taxed at the taxpayer’s individual rate. The highest individual federal income tax rate is currently 37%. On the other hand, assets that you sell after having owned them for more than 12 months, will have the profits treated as long-term capital gains and the maximum tax rate on capital gains for most taxpayers is 15%.
Clearly, sellers often prefer the sale of assets to be treated as capital gains because it will save on taxes but this decision is not entirely up to the seller. That being said, there is some flexibility, and negotiations between the buyer and seller in terms of the allocation of assets become very important.
Is the sale structured where it requires payment installments or is it all-cash?
As the seller, if you agree to take payments in installments, you can defer paying the taxes until the payments are received from the buyer. For buyers, they need to consider that this could cost them more as the seller could charge interest as receiving payments in installments over time does increase the seller’s risk.
Is the sale an asset sale or a stock sale?
When selling a sole proprietorship, a partnership, or an LLC, the sale may be treated as the sale of separate assets. However, when selling a corporation, it is possible to be sold as a stock sale as opposed to an asset sale.
Making this distinction is important because, depending on the type of legal entity, if the corporation sells its assets, proceeds may be taxed twice (once in the corporation AND again when the funds are distributed to the shareholders). On the other hand, a sale of stocks is taxed once, saving the seller money. Negotiations will be critical when determining the type of sale as the buyer will commonly want an asset sale so they can take more deductions on depreciation.
In the case of a deal between two corporations, can the sale be treated as a tax-free merger?
If one corporation is buying another corporation with an exchange of stock, this could mean no taxes need to be paid by anyone. But, this would only apply if there is no cash involved because the IRS has clear rules about this.
If you have any questions about the taxes after a business sale, do not hesitate to ask one of our local business advisors in northern San Diego. In all instances it is strongly recommended that both sellers and buyers consult with experienced tax CPA’s before entering into any type of sales agreement.
Contact us here at Transworld Business Advisors San Diego North if you are interested in learning more, seeing how you can sell your business quickly, or finding out if now is the right time for you to sell.