If you’re thinking of selling a business, keep these seven tax considerations in mind.
Baby boomers own 2.3 million businesses, according to Project Equity. This nonprofit organization predicts that 6 out of 10 owners plan to sell their businesses within the next decade. If you’re among this number or a younger-generation owner thinking of selling a business, keep these seven tax considerations in mind.
1. Negotiate everything for the sale of a sole proprietorship
Unlike a sole proprietorship, this is sold as if all assets were sold separately.
Most investments yield low-tax capital gains. Inventory sales provide regular revenue. Parties negotiate selling conditions, including allocating the purchase price to the business’s assets.
IRS Form 8594, Asset Acquisition Statement, shows seven classes of assets to which you must allocate the purchase price. The first class includes cash and checking accounts, to which you allocate the purchase price dollar-for-dollar. The final class (class VII) is for goodwill and going-concern value. This is the intangible asset that commands part of the purchase price. The more goodwill the business had, the greater the allocation to this class.
Negotiation takes place regarding the distribution.
The seller wishes to assign as much as possible to assets with a capital gain, such as goodwill, whereas the buyer wishes to assign as much as possible to assets that lose value over time, such as equipment and real estate.
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2. Sell a partnership interest
The selling of a partnership interest results in capital gain or loss. Unrealized receivables or inventory gains or losses are classified as ordinary. Opportunity Zone investments delay capital gains (see #7).
3. Decide on a corporate sale of stock or assets
If you own a corporation, you can choose how to set up the sale: you can sell stock or call it a sale of assets. Most sellers prefer to just sell the stock and report only the capital gain on their taxes. But buyers prefer an asset sale because it gives the assets they’re buying a higher basis. Again, the structure of the sale can be decided through talks between the parties. For example, a seller might be willing to take a little less for a stock sale because they would have to pay more in taxes if they sold the stock as an asset.
4. Make an S election
C and S businesses can sell shares or assets. S corporations save taxes. A C corporation’s sale gains are subject to an extra 3.8% Medicare tax. If the business is a S corporation and the owner is actively participating, the gain is not taxed. A C corporation anticipating a sale can chose S status if it meets the requirements.
5. Use an installment sale
One of the ways to minimize the tax bite on profits from the sale of a business is to structure the deal as an installment sale. If at least one payment is received after the year of the sale, you automatically have an installment sale. But there are some points to keep in mind. You can’t apply installment sale reporting for the sale of inventory or receivables. And there’s always a risk in an installment sale arrangement that the buyer will default. Details on installment sales in the instructions to Form 6252.
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6. Sell to employees
If you prepare ahead, you can sell your C corporation to your employees through an ESOP (ESOP). ESOPs are employee-owned (IRS has further info). From the owner’s standpoint, there are captive buyers. You establish a fair price and get ESOP cash. Roll the proceeds into a diversified portfolio to defer text.
You can also use ESOPs for S corporations, but the deferral option for an owner doesn’t apply. Revoking an S election in anticipation of a sale is something to consider.
7. Reinvest gain in an Opportunity Zone
They can reinvest their proceeds in an Opportunity Zone (you go into a Qualified Opportunity Zone (QOZ) Fund for this purpose). Gains must be recognized by December 31, 2026, or earlier if the fund interest is disposed of before that date. If you hold the investment beyond this date, you may be able to take advantage of future appreciation tax-free. An owner who sells his or her business doesn’t have to put all the proceeds into a QOZ, but tax deferral is limited accordingly. Find details about Opportunity Zones from the IRS.
Many business owners find it difficult to walk away from their businesses. They love the action and don’t have personal plans for their time in retirement. They can consider negotiating a consulting agreement with the buyer. This gives the departing owner ongoing income and continuing tax breaks (such as claiming the qualified business income deduction if eligible).qualified business income deduction
A sale of a business is a highly complex matter from a legal and tax perspective. Don’t proceed without expert advice.