If you are planning to sell a business, it’s crucial to consider the tax implications. Without strategic planning, a higher portion of your proceeds might need to be paid to the Internal Revenue Service (IRS) if you don’t plan accordingly. While an experienced tax professional can help you structure the sale of your business for tax optimization, the following are several approaches to consider:
Asset Sale
With an asset sale, specific business assets are sold, rather than ownership of the entire company. Most buyers prefer this structure because it allows them to avoid the seller’s past liabilities and benefit from a step-up in basis for tax purposes. The buyer can claim greater depreciation and amortization deductions, while the seller retains the business entity and remains responsible for the company’s liabilities.
Business assets that may be transferred during an asset sale can include:
- Equipment
- Inventory
- Good will
- Real estate
- Trademarks
Sellers often incur a higher tax burden in an asset sale, compared with a stock sale. Notably, gains on assets such as machinery are often taxed at ordinary income tax rates, which are greater than capital gains rates. However, goodwill is subject to capital gain treatment.
Stock Sale
A stock sale is a transaction where shares of the company are sold. Many sellers prefer structuring business sales in this way due to the favorable tax treatment. Unlike an asset sale, which is taxed at ordinary tax rates, the proceeds of a stock sale are typically taxed at long-term capital gains rates. In addition, this type of sale avoids double taxation for corporations. While an asset sale would be taxed at both the corporate and individual levels, shareholders are only taxed on the proceeds of a stock sale.
Installment Sale
With an installment sale, the buyer pays the seller over the course of more than one tax year, rather than in a lump sum. This can be beneficial for sellers who wish to spread the taxable gains over several years in order to avoid being moved into a higher tax bracket. The seller essentially finances the purchase for the buyer and holds a security interest in the property, which can be taken back if the buyer defaults.
Each installment payment has three parts for tax purposes:
- The return of basis — This is the original investment in the business, which is not taxed.
- Capital gains — The profit on the sale is taxed at the capital gains rate.
- Interest on the installment — The interest is taxed as ordinary income.
The seller only pays taxes on the installment in the year they actually receive the money.
Sale of a Partnership Interest
Another way a business sale can be structured is by selling a partnership interest. With these types of transactions, a business partner agrees to sell their interest to another party. The transaction is generally treated as the sale of a capital asset — and any profit is considered a capital gain. However, there is an exception for “hot assets,” such as inventory items or accounts receivable. This part of the gain may be treated as ordinary income.
Contact an Experienced Tax Professional
As you can see, there are a lot of factors to be mindful of when selling your business. A knowledgeable CPA can advise you how to structure the transaction for the most favorable tax treatment to keep more of your money in a sale. Based in Fairfield, Connecticut, Rolleri & Sheppard CPAs, LLP provides strategic guidance to business owners and individuals for tax planning matters. Contact us online or call (203) 259-CPAS to schedule a consultation.
