Selling a business is a major financial decision, and there’s a lot to consider—determining its value, finding the right buyer, and successfully negotiating a deal. In addition, one crucial factor that often gets overlooked during the pre-sale process is taxes. Understanding the tax implications of selling your business can help you maximize your earnings and ensure a smooth transition.
In this article, we’ll break down key tax considerations and strategies to help you navigate the business sale process:
How Taxes Affect the Sale of Your Business
When you sell a business, the transaction can be subject to multiple taxes, including capital gains tax, ordinary income tax, and state taxes. The way the sale is structured—whether as an asset sale or a stock sale—can significantly impact how the sale is taxed. Here’s how each option plays out:
Asset Sale vs. Stock Sale
- Asset Sale:
In an asset sale, the buyer purchases individual assets of the business, such as equipment, inventory, and intellectual property. Sellers often face higher taxes in an asset sale because certain assets (like equipment) may be subject to depreciation recapture, which is taxed as ordinary income. The remaining gains are then taxed at capital gains rates.
- Stock Sale:
In a stock sale, the buyer purchases shares of the company, taking ownership of the entire business. This option is usually more tax-friendly for sellers since most of the gain is treated as a capital gain, which is taxed at a lower rate than ordinary income.
Key Tax Considerations
Capital Gains Tax
Most profits from selling a business are taxed as capital gains, either short-term or long-term, depending on how long you’ve owned it. Long-term capital gains (for assets held longer than a year) are taxed at a lower rate—ranging from 0% to 20% in 2023—depending on your income.
State and Local Taxes
On top of federal taxes, state and local taxes can also come into play. Some states don’t tax income at all (like Florida and Texas), while others (like California) have rates as high as 13.3%. Knowing your state’s tax laws is essential to accurately estimate how much you’ll take home.
Depreciation Recapture
If you’ve claimed depreciation on business assets, the IRS may require you to “recapture” a portion of that depreciation upon sale. This recaptured amount is taxed as ordinary income, which could lead to a higher tax bill than expected.
Strategies to Reduce Your Tax Burden
While taxes are unavoidable, there are ways to reduce how much you owe and maximize your earnings:
Structure the Sale Wisely
Deciding between an asset or stock sale can have a big tax impact. While buyers often prefer asset sales, these types of transactions tend to tax sellers significantly more than stock sales. Work with your tax advisor to find the best structure for your situation. Negotiating a middle ground can help both sides benefit.
Take Advantage of the QSBS Exclusion
If you are opting for a share sale and your business qualifies as a Qualified Small Business under Section 1202 of the Internal Revenue Code, the selling shareholders may be able to exclude up to $10 million (or 10 times the original investment, whichever is greater) of capital gains from federal taxes.
Consider an Installment Sale
Rather than receiving a lump sum, an installment sale allows you to spread payments over multiple years. This can help keep you in a lower tax bracket, reducing your overall tax burden.
Maximize Retirement Contributions
Before finalizing the sale, consider putting more into tax-advantaged retirement accounts like a 401(k) or IRA. This can lower your taxable income for the year and boost your long-term savings.
Plan for Estate Taxes
If your business is part of your estate, estate taxes could significantly reduce what you pass on. Working with an estate planner to set up trusts or gifting strategies can help minimize future tax liabilities.
Preparing for a Tax-Efficient Sale
The earlier you start planning, the better positioned you’ll be when the time comes to sell. Here’s how to reduce your tax burden as much as possible:
Review Your Tax Situation
Go through your financial records and tax filings to identify potential issues that could arise during the sale. Make sure everything is in order, and address any outstanding tax liabilities in advance.
Optimize Your Business Structure
The legal structure of your business (LLC, S-Corp, C-Corp) can affect how much you pay in taxes when selling. Consult a tax professional to see if restructuring before the sale could work in your favor.
Keep Detailed Records
Having proper documentation—such as asset valuations, depreciation schedules, and tax elections—can help support your tax positions and ensure a smoother transaction.
Work with Professionals
Selling a business is complex, and taxes add another layer of difficulty. A knowledgeable team—including a business broker, tax advisor, and attorney—can help you navigate the process and make informed decisions.
Selling a business is a big milestone, and taxes play a major role in determining how much you walk away with. Whether you’re looking to sell soon or just starting to think about it, addressing tax considerations early on will put you in a stronger financial position. The key is early planning and working with experts who can guide you through the process.
To see how The FBB Group can assist you through the business sale process – from preparations to final closing – contact us online today.