How to Minimize Taxes When Selling Your Business
Updated: May 30
Project Equity estimates that 60 percent of small business owners will sell their businesses within the next decade. Here are several factors to consider when deciding whether you want to sell your business and when the best time to sell it is. One of them is the tax implications of your decision. You can take steps to minimize taxes if you make some decisions before the sale.
How To Receive Payment
The first decision to make is how you'll receive payment. Will you receive all of it upfront or finance it over time?
Receiving all the proceeds at the sale's closing minimizes risks because you don't have to worry about the buyer's ability to pay in the future. The downside is that receiving all the money in one year will likely push you into a higher income tax bracket, meaning you'll lose more of your gains to taxes.
Deferring payment over many years avoids this tax trap. If you choose to do this, however, you'll want to either work with a third-party deferral finance company or take collateral to ensure you'll receive the rest of the money.
Allocating The Purchase Price
The IRS has specific rules about what constitutes capital assets vs ordinary assets. However, you can still have some control over how much of the purchase price goes toward capital assets. The more of the purchase price you can attribute to capital assets, the less your tax liability.
You'll want to negotiate a deal with the buyer that puts most of the purchase price toward these capital assets. If you own a corporation, you can structure it as a sale of stock, which will be considered a capital gain. Or if your business is a partnership, you'll sell the partnership interest and be able to count the income as a capital gain.
The challenge is that the buyer will gain more immediate tax benefits by classifying more assets as ordinary income. Capital assets depreciate, so their deductibility is amortized over time. One way to resolve this dilemma favorably to both buyer and seller would be for you to sell for less if the deal is structured as a stock sale, which might still net you more money than if you'd given your profits to the IRS.
What are the tax implications of selling a business?
When selling a company, there are a variety of tax ramifications that a buyer and seller need to be aware of.
To begin, there is the possibility of imposing a tax on the profit made from the sale price. This is a tax that is applied to the profit that was produced from the sale, and the rate of the tax will change based on the nation in which the sale takes place.
In addition, prior to the completion of the sale, all of the company's outstanding financial obligations, including any and all debts, must be settled. This includes any loans that are still owing in addition to any back taxes that are owed to the government.
Last but not least, it is essential to keep in mind that the buyer is almost often the one who is responsible for paying any transfer taxes that are owed.
These are the taxes that are imposed on the process of changing ownership of a company, and the amounts that must be paid might be quite different from one jurisdiction to the next. Before selling a company, it is essential to have a discussion about taxes with a financial professional who is qualified in the field.
How is the gain or loss on the sale calculated for tax purposes?
A gain or loss on the sale of a business is determined for tax purposes by establishing the difference between the amount realized from the sale and the business's adjusted basis. This difference is used to calculate the gain or loss on the sale of the business.
In general, the original cost of the business is added to any improvements that have been made throughout the course of its existence to arrive at the adjusted basis.
If the amount realized from the sale is higher than the basis that was adjusted, then the amount realized from the sale will be considered a capital gain and will be subject to taxation at more favorable rates.
A capital loss will be incurred in the event that the amount realized is lower than the adjusted basis of the investment.
It is important to keep in mind, however, that each year a taxpayer is only allowed to deduct a certain percentage of their total capital losses. As a result of this, it is essential to speak with a tax expert before selling a business in order to ensure that you are making the most of all of the deductions that are at your disposal.
Are there any special considerations to take into account when selling a business?
When it comes to selling a company, there are a number of key factors that need to be taken into mind. To begin, you should make it a top priority to check that the price you are paying for your company is as competitive as it can possibly be.
This requires you to conduct research and have a grasp of the value that your company currently holds in the market.
In addition to this, it is essential to have a complete comprehension of the terms of the sale, which should include any and all conditions and uncertainties that may be associated with the transaction.
Additionally, it is essential to give careful consideration to the tax implications of the sale, since these might have a substantial influence on the total proceeds of the transaction.
In conclusion, in order to get the most favorable end possible, it is essential to maintain a patient disposition and to have an accurate perception of the amount of time the transaction will take.
You may improve the likelihood of a successful sale by ensuring that each of these considerations is given careful attention.
How can you minimize your tax liability on the sale of a business?
You should talk with a tax expert as soon as possible to ensure that you are making the most of all of the deductions that are open to you. This is one of the most crucial things you can do.
For instance, you might be eligible to deduct the costs of professional services, such as those associated with legal representation or accounting work.
If you sell the assets of your business rather than the business itself, rather than having to pay taxes on the sale of the firm itself, you may be entitled for a special exclusion.
Because of this, you may be able to reduce the amount of taxable gain associated with the sale. In addition to this, it is essential to give thoughtful consideration to the timing of the transaction.
It is possible that you may be able to take advantage of lower tax rates if you are able to postpone the sale until after the first of the year. You can help to reduce the amount of tax liabilities associated with the sale of your business if you invest some time and effort into planning beforehand.
What are some common mistakes made when selling a business?
One of the most prevalent mistakes is a lack of advanced planning. It can be challenging to get the greatest possible price for your company if you do not have a crystal clear notion of what it is that you want to accomplish.
In addition to this, it is essential to have a solid understanding of the buyers' market and to be aware of potential investors in your business.
Underestimating the value of your company is a second mistake that can be made. Many business owners incorrectly estimate the value of their company, and as a result, they sell it for a price that is significantly lower than what it could have been sold for on the free market.
Last but not least, a significant number of sellers do not take into account the financial ramifications of a sale. It is possible that you will wind up paying a considerable amount of money in taxes, which could cut into your profits if you do not organize your finances carefully.
You can significantly improve your chances of securing the most advantageous price for your company if you steer clear of the hazards listed above.
Other Factors to Consider
Another way to lessen the tax bite from selling your business is to reinvest the capital gains into a Qualified Opportunity Zone.
This will defer taxes on the amount you invest through December 2026. To qualify, you'll need to make the investment within 180 days of your sale. You can also sell a C-Corporation to your employees gradually as part of an ESOP (Employee Stock Ownership Plan).
This has several advantages in addition to tax-related ones. For one, the employees already have a stake in the business and would likely be able to continue operating it after your retirement. The other is that you don't have to search around for buyers.
When the time to sell comes, you set a reasonable price and receive cash from the ESOP, which you'll roll over into a diversified portfolio to defer taxes on the gain.
While you can also use an ESOP if your business is an S-Corp, the deferral option isn't applicable. If you plan, however, you can revoke your S-Corp. classification as the sale date draws near.
Planning for your sale is critical. The earlier you can anticipate the sale, the more options you'll have for structuring it to your advantage. Take into account your legal structure, whether sole proprietorship, S- Corp., or C-Corp. and change the structure if you need to as the sale date approaches.
Consider whether you can provide financing for the sale or if you can negotiate with a third party to do so to stretch your gains over time.
Negotiate with the buyer about how much of the purchase price will go toward capital assets and look for ways to defer your gains through other investments such as Opportunity Zones.
Selling a business is complex. Consult with an expert well ahead of your sale date to achieve the most favorable tax outcome.