Selling your small business comes with several tax implications, depending on factors like the sale structure and the nature of the assets involved.
To get an overview of key tax issues, I spoke with Adrienne Stewart, CPA/ABV, a senior manager at Larson Gross, p.l.l.c. in Bellingham, Washington. She specializes in strategic, forward-looking tax planning and preparation, and she also assists individuals and businesses with their valuation needs.
Adrienne cautioned this article contains general information and opinions and serves only as a summary of certain issues relevant to business owners. The content addresses these topics as of the date posted and doesn’t provide, nor should you rely on it for, accounting, legal, tax, insurance, or investment advice. Always consult your personal tax professional when considering the tax implications of selling your business.
Ways to Sell Your Business
Adrienne explained that the most common way to sell a business is by selling its assets. A business typically has two main types of assets:
Tangible Assets
These are physical items your business owns, such as equipment, machinery, buildings, and inventory.
Intangible Assets
These include non-physical items like intellectual property (patents, trademarks), brand reputation, goodwill, and customer relationships.
When you sell your businesses’ tangible assets, you will generally pay regular income tax on the gain of those assets. Gains on intangible assets, however, are taxed at capital gains rates.
Stock Sale
Another option for selling a business is through a stock sale. With a stock sale, the owner is also taxed at a capital gains rate. If your business operates as a C or S corporation or LLC, you can pursue either an asset or stock sale option. However, a sole proprietor can only sell assets.
A stock sale might be less complex and less costly to execute, but buyers generally prefer an asset sale because they receive preferential tax treatment. Buyers also tend to avoid assuming legal liabilities, which often come with purchasing the stock of a company.
Capital gains tax rates vary depending on how your company is structured (C or S corporation, LLC, or sole proprietorship) and income level. State income tax rates can also come into play. Adrienne again urged consulting your tax professional when it comes to state income taxes on the sale of your business.
Minimizing Tax Costs
I asked Adrienne if there are any strategies to minimize the tax burdens of selling a business. Outside of sales involving real estate, there aren’t many ways to defer the gain. If your business includes real estate, you might use a Section 1031 exchange, which involves working with a qualified intermediary to purchase a replacement property within a specific timeframe that meets IRS requirements.
There are deductions you can use to offset the sale price. Legal fees, accounting fees, broker fees or commissions, and appraisal fees related to the sale of your business directly offset the purchase price as deductions.
The only other way to defer gain on other assets is carrying the contract and electing an installment sale treatment. In this type of sale, the buyer may make a down payment, and you function as a bank, carrying a contract for the remaining sales price plus interest that the buyer pays over time.
In an installment sale, you will be taxed on 100% of the interest and some or all of the principal amount you receive. The amount of principal you’re taxed on depends on the basis. “Basis” refers to the amount used to determine gain or loss when an asset is sold. It is usually the original purchase price, adjusted for factors over time. For example, if your business has a 25% basis, only 75% of the principal would be taxable.
I asked Adrienne if she anticipates any upcoming tax law changes that could affect the tax treatment of a business sale. She explained that federal and state tax laws are unpredictable. The only certainty is that the 2017 federal tax law changes will expire at the end of 2025. Without intervention from Congress and the President, we will revert to the tax laws of 2017, including income and capital gains tax brackets.
Advice for Business Owners Looking to Sell
My final question for Adrienne was what advice she would give to any business owner considering a sale. Her answer? “Run the numbers!” In other words, know the after-tax value of your business. I couldn’t agree more. As a former financial advisor, my top rule to clients was that it doesn’t matter what you make – it only matters what you keep!
I hope this article gives you insights into the tax impact of selling your business. To echo Adrienne’s advice, always consult your tax professional as you weigh your options.
Let’s Have a Conversation:
Are there any other challenges or questions you have about selling your business? Feel free to leave a comment below, and I’ll answer your question or address the issue in a future blog post. Thanks for reading!