It’s that constant life-companion – taxes. And we all know, there’s no getting around them – even after the successful sale of your business, Uncle Sam will be expecting a cut. So, when selling a business, it’s important to be aware of the tax implications that may arise.
Depending on the structure and nature of the business, the sale may be subject to capital gains tax, ordinary income tax or even potentially trigger additional taxes such as depreciation recapture. Proper tax planning prior to the sale can help minimize potential tax liabilities — and maximize what you are left with after the sale. Overall, it is important to keep in mind that the sale of a business can have significant tax consequences and proper preparation is necessary for a successful transaction.
This article details tax considerations when selling a business, and the taxation strategies to have in place to minimize costly liabilities. NOTE: Destined does not provide specific tax advice and it is important for each business owner to consult their licensed tax professional.
What Is the capital gains tax & how does it affect your business being sold?
The capital gains tax is a taxation system that applies to the profits made from selling company stock, certain business assets, property or other investments. This includes the sale of a business. Depending on how long the asset was owned for and the individual’s tax bracket, the federal capital gains tax rate can range from 0-20% or more, plus any applicable state taxes.
When selling your business, it is important to consider the impact of the capital gains tax. This will affect the amount left for you from the sale and should be factored into negotiations and financial planning.
The tax strategies to consider when selling your business
The sale of a business can be a complicated process, and it is important to consider the potential tax implications. Here’s how to strategize toward a minimal tax obligation before the sale of your business.
Structure the sale
One strategy to minimize taxes is to structure the transaction as a stock sale, rather than an asset sale. This allows for capital gains tax rates to be applied versus the often-higher ordinary income tax rates on many asset sales.
Defer your income
Another option is to defer income through an installment sale. However, it is important to carefully consider the terms of the installment sale and consult with a tax professional to ensure compliance with applicable regulations.
Use tax incentives
Taking advantage of tax incentives can potentially minimize taxes on the sale proceeds.
For example, Section 1045 rollover. This is an incentive that allows a founder or stockholder whose company has been sold, to defer capital gains. Simply, the proceeds from the sale are put into replacement stocks like QSBS – Qualified Small Business Stock.
It is important to discuss options like these – of which there are a few – with your tax advisor and determine which strategy will work best for your specific situation.
Why governments tax the transaction of a business being sold
Governments tax the transaction of a business being sold in order to generate revenue for their budgets and fund public services. This type of taxation is also known as a “business transfer tax,” or a “business transfer duty.”
Additionally, taxing the transaction of a business being sold can serve as a way to regulate economic activity and promote fair competition within industries. By imposing a tax on business transactions, governments can discourage the consolidation of large corporations and encourage the growth of small businesses.
Overall, taxing the transaction of a business being sold is a common practice used by governments to generate revenue and regulate economic activity.
Taxation aside, here are the advantages of selling a business
The decision to sell a business is not made lightly, but there can be significant advantages for doing so, even when factoring in the associated tax implications.
One advantage is the potential for a large financial gain from the sale. The proceeds from the sale can then be reinvested into other ventures or used for retirement planning. Additionally, selling a business can bring much-needed closure and allow the owner to move on to new opportunities or projects.
Finally, selling a business can also help consolidate and streamline operations within an industry or market, creating a more efficient and effective system overall.
While taxes must be taken into consideration during the selling process, the potential benefits and advantages should also be seriously weighed in making this important decision – because indeed, sometimes they’ll outweigh those tax drawbacks.
No need to fret when it comes to that dreaded ‘tax’ word. Destined is your M&A sell-side advisor, and we’ll always work with you and your tax professionals to get you to your goal with simplicity and profitability as overarching goals.