Tax Considerations When Selling Your Business
You’ve found a qualified buyer for your business, and they’ve agreed to your price. Before you cash the check and move on to the next phase of your life, you’ll have to think about paying taxes on your bounty. Be aware of these tax considerations during the planning and negotiation stages of your sale, and you won’t pay as much to Uncle Sam.
1) Goodwill and Taxes
The sale of business assets may include an intangible asset called goodwill. Goodwill involves the business as a whole and its good reputation with customers and the public. For the purpose of selling a business, the value of goodwill is the difference between the asking price for a business and the fair market value of its assets minus liabilities. It’s a capital asset and is eligible for good capital gains tax rates.
2) You May Qualify for a Tax-Free or Tax-Deferred Sale
Most sales of businesses are subject to tax, but you may qualify for a tax-deferred sale. Sellers who exchange S or C corporation tax for a buyer’s corporate stock may receive tax-free status if it meets IRS rules for tax-free reorganization. You’ll need to receive 40 to 100 percent stocks in the transaction for a tax-free exchange to qualify for an asset transfer tax free, but the buyer would have to give you 100 percent stock. These tax-free transfers apply to corporations, not other types of business structures.
You may qualify for tax-deferred status if you sell your corporate stock to an employee-stock ownership plan (ESOP) and the profits are reinvested with other securities with a pre-tax status. Maneuvering ESOP transactions can be tricky, so contact a finical advisor before choosing this route.
3) Follow IRS Allocation Rules
IRS allocation rules for the business purchase price state tangible assets are assessed at the appropriate fair market value (FMV) in a specific order. General deposit accounts and cash are listed first, followed by certificates of deposit, stocks and securities, accounts receivable, inventory and property, other assets, copyrights and goodwill.
4) Seller Financing and Escrow
If you agree to let the buyer pay in installments over time, you may defer the gain on the transaction until you receive seller payment (with interest). Deferral isn’t allowed for any part of the transaction involving gain on inventory or other ordinary financial items or on deprecation recapture.
A buyer may put part of the purchase price in escrow and pay it to you after it is apparent that transaction agreement warranties were followed. If you provide financing, there’s a chance the buyer may fail at running the company and default on the note, so if there’s any doubt about a buyer’s ability to pay, get all the money upfront or choose another buyer. If you decide on an installment sale, you can opt out of this method and pay all transaction tax immediately. This may be advantageous if you believe there'll be a large increase in capital gains rates during years installments are scheduled to be paid.
5) State and Local Tax Rules
State and local taxes must be paid after the sale of a business, and along with federal taxes, these charges can take a substantial bite out of the final sale amount.
Some states require a stamp tax on stock transfer, although stock transactions in most states aren’t subject to sales tax. Real estate transfers require payment of transfer or deed tax. In some states there is a transfer tax when an entity owning real estate is sold, even though no actual real estate changes hands.
Some states require pre-sale notifications regarding the potential sale of a business, and a tax clearance certificate must be obtained before closing the sale. The buyer will be liable for any of the seller’s unpaid employee state wage withholding, sales or us tax if this certificate isn’t secured.
Talk to your accountant and business broker about the state and local tax laws pertaining to sale of your company. Learn how the taxes will affect you and the buyer before negotiating to make the sales transaction easier for everyone involved.
6) You’ll Pay More Taxes if You Receive All Sales Proceeds at Once
When you receive payment from the buyer in one lump sum, you don’t need to worry about when (or if) you’ll receive remaining payments. That’s the good news. The bad news – it will push you into a higher tax bracket for the year you bank the payment. If you prefer getting all money upfront, plan for paying more taxes on the proceeds.
DISCLAIMER: BLS Consulting Services and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.