Important Tax Considerations when Selling a Business

The sale of a business is often an exciting time for the owner. This is the culmination of several years of hard work, and you are finally able to cash out and move on to the next phase of your life. In many instances, however, the focus is on the purchase price, and the tax consequences are largely overlooked. Failure to plan for taxes when selling a business is a huge mistake, and one that could become quite costly if you are not careful. Before finalizing the sale of your business, there are several tax issues that need to be addressed, some of the most important include:

The Type of Entity Being Sold

The structure of your entity will determine how much flexibility you have in structuring your sale. Sole proprietorships, partnerships, limited liability companies (LLCs) and subchapter S Corporations are all “pass through” entities, meaning the business income can be passed through directly to its owners without being taxed. C Corporations, on the other hand, are taxed both at the corporate and individual levels. This means, for example, that if you sell assets owned by the corporation, net income on the proceeds is subject to a corporate tax before the proceeds are distributed to the owners, where they are taxed again on the individual level. Conversion to a more flexible entity may be possible, but the conversion needs to occur far in advance of the sale to realize any tax benefit from it.

The Sale of Assets vs. the Sale of Stock

This is often a major point of contention in business sales. Buyers generally prefer to purchase the assets of an entity rather than its stock, while sellers generally prefer the opposite. Buyers want to purchase assets because of future tax advantages such as depreciation, etc. In addition, the purchase of assets rather than the entity overall can generally free the buyer of unknown seller liabilities. Sellers, on the other hand, want to sell stock because capital gains taxes are significantly lower than income tax, and in the case of C Corporations, the seller may be faced with double taxation on asset sales.

Lump Sum Purchases vs. Installment Sales

Sellers are often able to defer and reduce the taxes paid on the sale of the business by accepting lump sum payments over time. For example, if payments are made over five years, the income can be taxed in different years, and the seller may be able to lower his/her tax overall liabilities by being in a lower tax bracket. There is some risk in installment payments, however; particularly if the buyer does not do well and fails to keep up on payment obligations.

State and Local Taxes

In addition to federal income tax considerations, the seller must also examine the tax laws in their state and local jurisdictions. For example, some states impose a “stamp tax” on the sale or transfer of stock. On the other hand, asset sales may incur state and/or local sales taxes, depending on the jurisdiction. Asset sales may also involve multiple states depending on where the assets are located, which can cause additional complications.

Speak to a Tax Professional

Selling a business is a highly complex transaction, and the tax consequences can be significant if the seller does not plan out a strategy in advance. If you are considering selling your business, it is best to bring a local tax professional on your team to help guide the sale and ensure you emerge from the transaction in the best possible financial position.