There are many reasons and motivations for selling a business. On this list somewhere towards the top is the idea of cashing out and making money. Part of this is concern over how much money you will actually keep and how much you will need to give to the government in taxes.
The amount of taxes you pay will be determined in large part by the structure of the sale and the type of business entity you have. Your business was created as a sole proprietorship, a partnership/limited liability company (LLC), or some type of corporation.
If your business is structured as a sole proprietorship or as a general or limited partnership, the sale will be considered a sale of assets. The buyer only purchases the assets of the company, and not the liabilities or the business in its entirety. The assets of a business will usually include the inventory, accounts receivable, any fixed assets, customer lists and on-going business, and the company’s goodwill. The IRS says that the income derived from the sale of the sole proprietorship or the partnership’s assets must be reported on the individual owner’s tax return. An allocation of the purchase price to assets will determine the manner in which the income will be taxed. A business buyer generally would like to see the majority of the purchase price as possible allotted to assets that would be considered “ordinary gain” to the seller. As a result, the buyer can usually expense those items in the first year of business, rather than capitalizing the assets and taking a depreciation in subsequent years. When selling this type of business the attorneys at BoltNagi PC strongly you to consult with your tax and legal advisors as to the fair allocation of the sale of each asset.
The seller may enter into an installment sale with the buyer for the purchase price of the business. Simply stated, an installment sale is a sale where the seller issues a note to the buyer to have the purchase price paid over a period of time as defined in the sales contract. One advantage to this type of sale is that the seller is allowed to defer the taxes paid on the sale of the business over the term of the note. The profit that the seller sees each year of the note’s life would be calculated in the first year and then applied to the later years’ payments. The buyer pays interest on the note to the seller, and this interest must be reported to the Internal Revenue as interest income. In circumstances when it is believed that the tax rates are to increase or if the seller will be in a higher income tax bracket in future years, the installment sale may well not be the most beneficial vehicle for selling the business.
If the business you are selling is an limited liability company or a corporation, the sale may be an asset sale or a stock sale. An asset sale will result in the same tax consequences as if your business was a sole proprietor or partnership: the income is taxable to the owner.
In contrast, the sales of a C corporation creates the same types of income as other entities; however, the corporation itself—rather than the business owner—would be responsible for paying the tax on the income. The C corporation would then decide if the sales proceeds are attributable to the shareholders through distribution where the corporation doesn’t see a deduction or, in some cases, through additional compensation to the employee shareholders. Experts warn of a double tax on the sale income.
The sale of a company’s stock in a limited liabilty company (but not a single member LLC or partnership) or any form of corporation would mean capital gain treatment for the seller, in the same way as if they were selling shares of a publicly traded company. This type of sale is very beneficial to the seller because capital gains taxes are presently lower than standard income rates. A stock sale, however, can be less attractive to buyers in that they are required to take on the company’s current debts and liabilities.
Understanding the tax implications of the sale of your business will help you manage your expectations and better equip you when negotiating with potential buyers. Your exit strategy is critical and should be considered when you start your business. The attorneys in the Corporate, Tax and Estate Planning Practice Group at BoltNagi PC work with businesses in creation, merger, sale, and other operational matters. BoltNagi PC has attorneys with the skills and business experience to assist your company. Contact the attorneys at BoltNagi PC today to discuss your business concerns and receive sound, authoritative advice that you require.