How to Minimize Taxes When Selling Your Business
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.
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.