“…in this world nothing can be said to be certain, except death and taxes.”
This famous quote comes from a letter written by Benjamin Franklin, but similar ideas are attributed earlier to the writings of Daniel Defoe and Christopher Bullock. Who ever said it first, the sentiment is clear: Avoiding the burden of taxes may be as impossible as avoiding death itself.
Given the current environment, there’s a lot of speculation that taxes will be increasing in the near future at both federal and state levels, which would directly impact business owners. If you’re thinking about selling your business, it’s critical that you understand the tax implications of the sale whether you plan to sell to an outside buyer or employees or “gift” your business to family members.
You don’t need to be a tax expert, since you can rely on your advisors to do the detailed calculations, but you do need to have a basic understanding of how business transfers are taxed so you can evaluate your various exit options and understand how much you will “net” from each.
Tax Liability
Owners who are thinking about selling their businesses often don’t realize just how much of the proceeds of the sale will go toward paying taxes – whether it’s a sale to an insider or to an external buyer. The tax bite could be at least 30% and can be as high as 50% or 60% of the sale proceeds!
What really matters is the net amount, which is calculated as:
- Gross sale price
- Less all selling expenses
- Legal and other advisory fees
- Transaction fees
- Less Taxes
- Equals NET proceeds
The Fundamentals
The type of corporate entity you have and the way the transfer is structured are the primary drivers for how your transaction will be taxed. “Pass through” entities such as S corporations, limited liability companies (LLCs) and partnerships are taxed differently than C Corporations. Transactions structured as asset sales are taxed differently than stock sales and there is a way for stock sales to be taxed as asset sales! Sellers typically want to sell stock so they can receive capital gains instead of ordinary income tax treatment and buyers typically want to buy assets so they can depreciate the assets and avoid taking on the seller’s liabilities.
Understanding the fundamentals of how business transfers are taxed will enable you to evaluate the components of buyers’ offers much more thoroughly and negotiate accordingly. For example, transfers may include multiple types of income streams for the sellers, such as cash down payments, note payments, consulting fees, salaries, bonuses, benefits, earnout payments, and more, and these are all taxed differently.
What You Can Do to Minimize Taxes on Your Sale
Transfer tax is a very complex area. There are numerous nuances and you shouldn’t attempt to do it alone. As part of your overall exit plan, tax planning may involve many of your current advisors including your estate and wealth planning professionals, attorneys, CPAs, etc.
Taking the time to get properly educated on this topic may help you to realize significant tax savings and preserve your hard-earned wealth!
You should learn:
- How asset and stock sales are taxed.
- About tax basis or how much of your proceeds may not be taxed.
- The important influence that your business entity type (S versus C corporation versus LLC) has on your taxes.
- How deal terms and structure impact taxes.
- How to minimize taxes on family business transfers.
Our clients have saved millions of dollars on their business transfers by planning in advance and taking action to legally minimize their taxes (tax avoidance is legal while tax evasion is not).
