Upsize Stages: Minimizing your
UPSIZE STAGES: EXIT STRATEGIES
06 :: Minimizing your taxes
Talk to team early
to sort out myriad,
complex issues
One of the reasons it?s important to utilize an accountant when selling a business is the tax ramifications. Taxes affect many aspects of a transaction and are often a reason deals fall apart.
First, a seller wants to maximize the amount of the sale that will be treated as capital gains because that tax has the lowest rate available. Sellers must think about how they are going to get the money. If they sell their ownership interest they?ll have to pay capital gains tax on the difference between the original investment and what the business is worth now. Sometimes they can consider spreading out the payments over five to 10 years, which would allow them to spread out the tax payments as well.
If the parties do an asset purchase, which is more common in deals involving small businesses, it?s generally better for the buyer, who can pick and choose the items to acquire and then depreciate those assets based on the purchase price. That kind of a deal would typically be harder on the seller as those assets have typically already been depreciated. They would then have to report ordinary income on that portion of the sale.
Conversely, a stock sale entails the purchase of all assets and liabilities. Unless the seller wants to retain certain assets, such as real estate, he or she is typically going to be more interested in a stock sale, for multiple reasons.
First, if the business is a C corporation, an asset sale causes a double-tax situation where the seller pays on both the appreciation of assets and the capital gains on the sale of stock. The stock sale would be taxed just once.
S corporations and other business structures aren?t quite as onerous to sellers, but the corporate structure chosen when the business opens will have tax implications at the time of sale and affect the type of transaction that takes place.
Parties will often meet in the middle and do transactions involving both cash and stock. Those are complicated in that if 50 percent or less of the transaction is done in cash the Internal Revenue Service will delay taxing the stock until it is sold. But if the deal is for more than 50 percent cash, the IRS taxes the entire amount upfront, meaning that the seller ends up using more cash from the transaction to pay the tax.
A good CPA will know of other outlets for minimizing proceeds lost to taxes as well. For example, in S corporations and LLCs an owner pays taxes on the business?s profits. But if those profits are reinvested, they?re accumulated as retained earnings. It might be appropriate for a seller to remove those earnings from the corporation as part of the deal ? and to do so tax-free.
Also, non-compete agreements are taxed at ordinary tax rates, so minimizing the dollar amount allocated to such deals can lower the effective tax rate.
From a capital gains tax perspective, the current presidential election is worth keeping an eye on. Capital gains taxes are at historical lows, but observers note that Democrats currently hold both houses of Congress. If they gain the White House in November there?s a strong possibility that those rates could rise.
In addition to structuring a deal that is palatable tax-wise for both the buyer and seller, the deal structure will impact how the seller?s estate planning is set up. Again, there are few more complicated aspects to selling a business than the tax implications so talk to your team early.
