If you think you might want to sell your business, make sure you consider the impact taxes can have on the sale. The way your business and transaction are structured can have a major impact on your tax bill and profit. With pending tax laws increases within the next year, the timing of your sale may also play a significant role in determining your net profit. Understanding the tax implications of your business sale is a critical step in preparing to list it.
Stock or Asset Sale
Making the decision to structure your transaction as a stock sale or asset sale is an important catalyst in determining your final tax bill. Usually, a stock (ownership interest) sale is better for the owner. If your business is a C or S corporation, a partnership, or an LLC that is treated as a partnership for tax purposes, you can sell your ownership interest. When selling your stock in a business, your profits are taxed at long-term capital gains rates, currently a maximum of 20%, compared to a maximum rate of 37% on normal income. In addition, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they are eventually sold. Under the current tax law, the income passed through S corporations, partnerships and LLCs is also taxed at a lower rate on a buyer’s personal tax return. However, capital gains tax rates and rates for the highest income tax bracket could be increasing soon. If proposed rate increases are passed, the capital gains tax rate could see a significant jump, depending on your income level.
In contrast to a stock sale, and asset sale is where the buyer only purchases the assets of a business. This is the only option if a business is a sole-proprietorship or single-member LLC that is treated as a sole proprietorship for tax purposes. Asset sales produce a combination of capital gains income and normal income, and are taxed accordingly. This depends on how much of the purchase price is attributed towards assets. While the asset sale might be the only option for some business owners, for those who have a choice it is the one with a higher tax burden.
The amount of the purchase price allocated towards business assets can have a major impact on both buyers and sellers. The two parties typically have opposing interests, which can make negotiations difficult. Sellers generally prefer to have goodwill and intangible assets contribute as much as possible to the sale price, in order to take advantage of the lower capital gains rates. They prefer to allocate as little of the purchase price as possible towards equipment and other depreciable assets. This limits the amount of previous depreciation deductions they have to pay back. Buyers, on the other hand, can depreciate these assets quickly, and in some cases claim 100% depreciation in the first year. For this reason, they want assets to make up as much as the purchase price as possible. If you have a knowledgeable business broker handling the sale of your business, they can navigate you through these negotiations. Their experience with deal structuring can help find a “sweet spot” in asset allocation that is favorable to you and amenable to the buyer.
The type of corporation of your business operates as can also affect your taxes. One potential drawback of a C corporation is double taxation. This occurs when the business pays corporate taxes on the sale proceeds and then shareholders pay a second tax when those proceeds are distributed as dividends. This is not an issue for S corporations. Since they are pass-through entities, their income is taxed directly to shareholders at their individual tax rates. This means there is no entity-level tax, even in an asset sale. There is a special situation for a business that had been previously taxed as a C corporation, but switched to S corporation status. In this case, asset appreciation during a business’s time as a C corporation may be subject to two levels of tax, but this depends on how much time has passed since the change.
While partnerships and LLCs taxed as partnerships do not have stock, owners can sell their partnership interest. The tax implications are not the same as they are when selling stock in a company. The sale of partnership or LLC interests is the same as selling the company’s underlying assets, which results in some proceeds being taxed as regular income and some as capital gains.
Equipping yourself with the right knowledge can help you understand the tax implications of selling your business, helping you to make the right decisions about the way you structure the sale and negotiate the transaction. Deciding to sell your business right now can also help reduce the likelihood that you will be stuck with a larger tax bill due to pending tax law changes. This can help minimize your tax burden, so you can maximize your profit from the sale.
Working with a business broker can help you navigate through all of the tax law nuances and reach the highest profit potential of your business. The services of a business broker often pay for themselves, as the experience can be extremely valuable in negotiations and deal structuring. They can help you find hidden value in intangible assets, which will help to increase your sale price and help your profit to be taxed at a lower rate. If you are a Southwest Florida business owner considering the sale of your ownership interest, contact Corporate Investment Business Brokers (CIBB). We offer free business valuation estimates that can help you determine an accurate sales price for your business in the current market and get the most out of your sale.
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