Selling a business is extremely exciting and often takes years or decades of a dream to become a reality. Compared to other potentially large payments in life, such as the sale of real estate, selling a business can be quite complicated.
There are many different ways to structure a transaction and each has aspects that can be adapted to reduce the tax on sales. Here are a few different formats deals can be found and what to keep in mind for each.
NS the easiest settlement One time sale. The seller receives cash for the business, and the transaction is recognized in the year of sale. How this plays out depends on the business entity you are selling and if you are selling assets or stock.
Selling the stock of an S or C corp results in a capital gain for the seller, which is taxed at tax rates favorable to individuals. However, a buyer wants only assets or selected assets of the corporation. In that case, the C corp has to pay tax on the sale of the asset and the owners pay capital gains tax on distributions, creating two layers of tax.
If you are selling partnership assets or S corp assets, there is only one layer of tax because the shareholder or partner is the taxpayer (not the business entity). The sale of assets by the S corp results in a taxable gain similar to the sale of shares; However, the profit may be partly ordinary income, which is taxed at a higher rate.
The sale of partnership assets works in much the same way as the sale of S corp assets, with a layer of tax. However, capital gains rates on the sale of partnership units are not automatically taxed. a Rule Exists as part of capital gains for ordinary income on so-called “hot assets” such as inventory and accounts receivable.
There is a tax incentive for hidden gems for sellers of C Corp shares. Qualified Small Business Stock. This allows individuals to exclude up to $10 million or more of their basis from taxable income when they sell shares that were originally issued. The exclusion does not exist for partners selling partnership units or shareholders selling S corporation shares and has different requirements, but when you qualify, it is huge. If you sell for $10 million instead of paying $2 million to the federal government for capital gains tax, you pay nothing.
An acquisition becomes more complicated when the buyer is unsure of the value of the company they are selling, so the deal includes “earnings” along with some cash advance. an earnings trigger Additional payments When earnings or other negotiation goals are met.
Earnings can happen over the course of years, and it’s important for you to consider how likely the deal is to achieve the goals set out. If you end up with just cash on the table, would that be okay with you? If you don’t kill your earnings, will you still be happy?
From a tax perspective, you want the earnings to be tied to the success of the business, not to you in any way specifically. If the earnings have some tie in you as an employee—for example, if you need to be employed by the company to earn it—it becomes compensation, which is taxed at the ordinary income rate. , almost twice the capital gains rate.
Buyer owning a piece
Sometimes a buyer, such as a private equity firm, wants the seller to have the skin in the game. One way to do this is to offer the seller a minority ownership in the buyer as part of the sale.
When you receive the stock, you are taxed. Let’s say you are paying 20% tax. If you get $10 million in cash, you pay $2 million in taxes and put the rest in your pocket. But if you get another $10 million in stock, it will double your tax bill and eat into your cash portion of the transaction significantly, leaving you with $6 million in cash and $10 million in stock. will be given. In addition, you take on the risk of investing in the stock you are acquiring.
There may be ways to structure the deal so that you don’t pay taxes on the stock. For example, you may be able to postpone it. If the buyer is a partnership, instead of selling 100% of your business, you can contribute a portion of it to a tax-exempt partnership and take back units in that partnership without paying tax on them. For the cash portion, you will continue to pay tax, but you will defer tax on the component you contribute and take back ownership in the buyer. In the example above, you have $8 million in after-tax cash income and $10 million in partnership units with $2 million in tax that is deferred until you sell the partnership units.
Another factor to consider when you take the ownership percentage into the buyer is that you built the company and ran it, but after the sale, someone else is calling the shots. As a shareholder or partner, you still have to worry about the company’s value going up or down, but you have far less control over it than you once did.
The trading market is hot right now as multiple forces work together to create the market Friendly for both buyers and sellers. The situation is so fluid that the advice of a CPA familiar with your particular business is vital. Your CPA should be involved in your sales process, estimating profits and potential tax liabilities at the stage of the letter of intent through the completion of the sale.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice related to your specific situation.