Regardless of the reasons that one chooses to put their small business up for sale, it is important to take into account the tax consequences of selling a business. Depending on a variety of factors, the tax consequences of selling a business could drastically adjust the price of the venture. However, with the correct timing and tax knowledge, the tax consequences of selling a business can be minimized. It is important to understand the tax implications for both parties, since what may be beneficial to the seller may not be a positive for the buyer and vice versa.
When one sells a business, the IRS actually considers it a sale of multiple assets. Capital gains taxes are significantly lower than ordinary income taxes, so it is beneficial to the seller to have a majority of these assets priced as capital gains in order to reduce the amount that due in taxes.
If the seller receives all of the payoff within the first tax year, then this puts them at risk for being placed in a higher tax bracket. If the revenues are spread out among multiple years, then the tax ramifications will not be as strong. Therefore, it may actually mean a higher return in the long run if the seller does not require all of the sale price at the close. By accepting the purchase price in installments, the seller can defer payments to assets that are to be taxed as capital gains. Long-term capital gains taxes are the best rate that a seller can achieve. Or, if the seller defers the payment altogether, they will not have to pay the taxes until the capital is actually paid to them. Unfortunately, not all assets may fall under the capital gains category, and consequently will be taxed as ordinary income.
The buyer and seller must agree on what portion each asset will make up the purchase price, and then report the taxes identically to avoid being placed in a higher tax bracket. It is recommended that these allocations be written into the final agreement to ensure that the buyer and the seller are on the same page. The buyer will prefer a large portion of the sale price to be assigned to assets that depreciate quickly, in order to decrease the company's tax charges. However, depreciating assets are more likely to be taxed as income, so conversely, the seller will want to gain as much capital from the sale as possible, and will request more money be allocated towards capital gains.
Selling a C corporation is a more complicated matter, but lowering the tax consequences of a C corporation is possible. However, sellers must beware, because if the business is listed as a regular corporation, it could be subject to double taxation. Depending on the type of company, the tax consequences of selling a business may vary.
The tax consequences of selling a business can be difficult to understand and vary from situation to situation, therefore, it is imperative that sellers seek out an expert that can lead them to the ideal circumstances. The business brokers at George & Company will be able to assist in finding the best tax situation for your transaction. Contact us and we would be happy to speak to you in complete confidence.