Most business owners are focused on the value or selling price of their business, but something often overlooked early on is the tax consequences of selling their business and what the net proceeds will be.
It does little good to get a great selling price and then lose 50% of it to taxes, but with advance planning and a good tax advisor, you can minimize your taxes and defer as much as 90% of the taxes. Your particular taxes and savings will depend on a number of factors, so it is impossible to provide a one-size-fits-all answer as to what you will save, each business and transaction is unique. But a tax strategy will dramatically reduce your taxes and there are several tax strategies available that provide a means to defer and reduce the taxes on the sale of your business.
Here’s an overview of tax strategies used for both business sales and real estate sold with a business.
- Sales Trust
In a sales trust, you will simultaneously sell your business to a trust (not related to you) through an installment sale in exchange for a secured installment note. The trust then sells that business to the end buyer. The proceeds are then put into the trust where they will be invested. You can choose how much and when to receive payments from the trust. You pay tax on the payments as received.
- Monetized Installment Sale
A monetized installment sale functions very similarly to a Sales Trust. You will sell your business to another entity in exchange for a 30-year installment promissory note. The other entity will simultaneously sell your business to the end buyer. The proceeds go to the intermediary entity. Since you have not received any proceeds, you do not pay tax on the sale at this time, it is deferred. You receive your proceeds through the form of a loan from another institution equal to about 93% of the sales proceeds. You pay no capital gains tax until 30 years has passed.
- Charitable LLC
A charitable LLC allows you to donate an asset to a charitable LLC, The Charitable LLC then gives a portion of its shares to charity. You get a charitable contribution deduction for the value of your asset that you contributed. Future income is split between the charity and your portion of ownership of the LLC. You remain in full control of the LLC and its assets. This will also yield ongoing income reduction and tax savings in future years.
- Personal Goodwill
When you sell your business you may be able to allocate a portion of the sale to your personal goodwill. This can greatly reduce the overall tax liability associated with the sale because that portion will be treated as long-term capital gains instead of ordinary income.
- Opportunity Zone
An opportunity zone is an “economically distressed community”. The opportunity zone credit allows you to invest proceeds from the sale of an asset (business included) into an opportunity zone to defer and potentially eliminate a large amount of taxes.
- Conservation Easement
A conservation easement allows someone to give up the rights to undeveloped land. In turn, the IRS will give a charitable contribution credit of the amount that the land may have been worth had it been fully developed.
- Stock vs Asset Sale
Most business sales are done in the form of an asset sale, which is beneficial to the to the buyer in a number of ways, but unfortunately puts the seller in the highest tax bracket with some of the proceeds taxed at ordinary income rates. If the transaction is structured as a Stock Sale then most of the proceeds are taxed at the capital gains tax rate, thus dramatically reducing the seller’s tax liability.
Due to successor liability risks and the loss of depreciation for the buyer, it is often difficult to persuade a buyer to structure the transaction as a stock sale instead of an asset sale. However, there are several instances where a stock sale is a benefit to the buyer and even a requirement. These instances include the sale of a corporation with a contractor’s license and corporations with government or long-term contracts that need to be preserved. In some instances, a stock sale can be negotiated with the buyer when the offer is being constructed.
These are some of the more common strategies available when it comes to selling your business or large asset. There are many more to explore that are unique to certain situations. Most of these strategies include immediate tax savings as well as deferred savings in the future. The time value of money and inflation is another factor to consider when determining your exit strategy.
As with all advanced tax strategies, there is always some level of risk. The IRS is constantly changing rules and regulations every year. There is no guarantee that any strategy used will not come under IRS scrutiny or be written out of law in the future. Most of the strategies require in-depth legal and accounting knowledge of the IRS code. Be sure you are working with an advisor who is familiar with these strategies and up to date on all of the IRS changes.
Contact us for a free consultation with our CPA tax advisor that specializes in tax planning for business owners selling their businesses and/or real estate.