Reducing Taxes Owed From Selling Your Business

Before selling your business, it’s important to factor in every aspect of the sale, especially when it comes to taxes. Tax-related issues can have a major impact on the sale of your business. Some of these factors are predetermined by the IRS while others can be controlled or influenced by the seller.

The overall goal when selling your business is to reduce your tax burden and make as much off of the sale as possible. Here is some information about how the sale of a business is taxed and how you can reduce the taxes owed when selling your business.

Do You Pay Tax If You Sell Your Business?

Ben Franklin was right when he said there were only two things certain in life: death and taxes.

When you set up and run a business, you begin to accumulate a lot of expenses. To offset some of those expenses, you can take tax deductions to lower your net income. Then, you pay taxes on this remaining income amount. 

When it comes time to sell your business, you are required to pay taxes on the money you made off of the sale. So, the answer to the question is yes: you pay taxes while running a business and when you sell your business.

How is the Sale of a Business Taxed?

You will either pay a capital gains tax or the proceeds will be taxed as ordinary income. Proceeds from the sale of a business are mostly taxed as capital gains. However, you may have some assets that require being taxed as ordinary income.

Capital gains are taxed at a lower tax rate than ordinary income. If you sell your business after having owned it for less than a year, the proceeds are taxed as ordinary income.

What Factors Determine How Much Tax You Pay?

Based on the probability that the proceeds from the sale of your business will be taxed as capital gains, there are certain factors that affect how much you will pay:

• Your annual income the year the business was sold;
• How long you have owned the business;
• How much money you receive from the sale of your business;
• The amount of your total liabilities.

What Things Should You Consider From a Tax Perspective Before Selling Your Business?

There are some things to keep in mind before selling your business to make the most informed decisions at the time of the sale. These include the type of sale, type of business entity, purchase price allocation, state tax laws, value of the business assets, tax-free stock exchanges, and income tax rates.

Type of Sale

The sale of a business can be classified as a stock sale or as an asset sale. If your business is classified as a S Corporation or a  C Corporation, it will sell by shares of stock.

Asset sales, on the other hand, involve the sale of tangible and intangible assets. Tangible assets include property, equipment, and inventory. Intangible assets include things like business lists and goodwill.

Type of Business Entity

The type of business entity affects how taxes are calculated from the sale of your business. Sole proprietorships may base their taxes off of capital gains and be taxed as ordinary income since sales from inventory are taxed as ordinary income.

If a business is established as a partnership, the sale of a business is subject to capital gains tax. However, receivables or unrealized inventory is treated as ordinary income. Any equipment depreciation is taxed as ordinary income.

For  corporations, stock sales are preferred because the sale would be taxed as capital gains. However, where C Corporations are subject to a 3.8% Net Investment Income Tax, S Corporations are not.

Purchase Price Allocation

Purchase price allocation has to do with the value allocated to tangible assets and intangible assets. It’s generally better to allocate as much as possible to intangible assets since the capital gains tax rate is more favorable. How the purchase price is allocated can have a significant impact on the amount of taxes you will have to pay.

State Considerations

State tax laws vary. Where your business is located when it is sold can have an impact on how a business is taxed.

Value of Business Assets

Another thing to consider before selling your business is deciding on what value to assign your tangible business assets. These would include inventory, real estate, and equipment. The valuation of intangible assets, like brand recognition and intellectual property, is more difficult to determine.

Tax-Free Stock Exchanges

If the sale of your business is classified as an acquisition or a merger, you can defer your taxes by participating in a tax-free stock exchange. In this type of setup, the stock of one company is exchanged for the stock of another company.

How Can You Reduce or Avoid Paying Taxes When You Sell Your Business?

There are several ways to either avoid or reduce the taxes you owe when selling your business:

• Allocate as much of your proceeds as possible to intangible assets because they are taxed at a lower capital gains tax rate;
• Defer tax payments until a later date by participating in a stock exchange. If you sell your business in exchange for a number of shares of stock, you will not pay taxes until those shares are sold;
• Do an installment sale to spread out the taxes owed over time;
• Reclassify your C Corp as an S Corp if eligible to save a substantial amount in taxes.

Getting the Most Out of a Business Sale

Need help planning for the sale of your business?
Tools like Corvee’s tax planning software may help you quickly find the strategies available for saving on taxes at the time of the sale.