Tax Strategies for Selling a Business

Selling your business can symbolize a tremendous milestone reflecting years of hard work and dedication. However, without a careful tax strategy, unnecessary capital gains taxes can erode your hard-earned proceeds.

Fortunately, there are legitimate tax strategies for selling a business that can help mitigate the loss of those proceeds. First, you need to understand how to avoid tax penalties when exiting business through sound strategies, what common mistakes to avoid, and how working with a deferred sales trust law firm can help you make the most of this momentous occasion.

If you’re looking for legal and tax planning tips before selling a business from experienced wealth attorneys, 453 Trust Powered by Pennington Law can help. Contact us today to learn more.

How to Avoid Capital Gains Tax When Selling a Business

When you sell your business, the IRS may consider part, possibly even all, of the proceeds as capital gains. That could mean paying 20 percent or more in taxes without even considering state taxes or the net investment income tax on the sale of a business. You’re not out of options: take a look at these legal and tax planning tips before selling a business.

Deferred Sales Trust (DST)

A deferred sales trust (DST) can make a tremendous difference when looking to maximize proceeds after the sale of a business, yet many business owners don’t utilize them. That’s why we call them “The Tax Tool You Didn’t Know You Had.”

In a DST, you transfer the proceeds of your business sale to a third-party trust. The trust holds the proceeds and reinvests them, redistributing them to the former business owner over an installment period. This strategy allows the taxes to be spread out or deferred over years or even decades. It can also enable you to retain or reinvest more capital and possibly even lower your overall tax burden by keeping you in a lower tax bracket.

Other Installment Sales

You can spread out your tax liability through other installment sale methods, such as a 1031 exchange or structured installment sale. Both strategies allow for tax deferral, but they vary in their requirements, costs, complexity, and risk. At 453 Trust Powered by Pennington Law, our experienced attorneys can review all available options to reduce the tax burden on selling your business.

How Installment Sale Agreements Can Lower Your Tax Bill

Under IRS Code Section 453, you can spread your capital gains tax liability by agreeing to an installment sale that allows you to receive payments over several years. This not only spreads your tax hit across that span but can also keep you in a lower tax bracket and reduce your overall tax burden.

However, the installment sale strategy comes with certain risks. For instance, the buyer may face financial issues and default on their payments, which can impact your credit. A deferred sales trust offers a safer alternative to this by providing professional trust management and greater control over the investment and distribution of your proceeds.

Common Mistakes When Selling a Business and How to Avoid Them

If you want to know how to avoid tax penalties when exiting a business, it’s critical to understand some of the common mistakes people make in these situations. Examples include:

• Waiting too long to plan for taxes – Selling a business is complicated and can be overwhelming. If you don’t consider the tax implications at least 12 months before the sale, you can severely limit your options for mitigating your tax hit.
• Not considering the buyer’s tax perspective – It’s common for the buyer and seller to have opposing preferences regarding deal structure. Failing to work out a mutually beneficial agreement with an experienced advisor can have massive tax implications.
• Ignoring the impact of all taxes – Many business owners focus too much on the federal taxes associated with selling their business and ignore state and local tax implications. These taxes can have a larger impact on the proceeds than many assume.

How Your Business Structure Affects Your Tax Strategy for Business Sale

Effective tax strategies for selling a business will vary based on the business structure. Here’s how:

• Sole proprietorships and single-member LLCs – Typically, an asset sale is taxed at capital gains rates. A DST or installment sale is likely the best way to spread the gain, keep you in a lower tax bracket, and maintain cash flow.
• Partnerships and multi-member LLCs – You’ll likely choose either an asset sale or a sale of partnership interest. Depending on which you choose, a DST or Section 754 election may be your best option for mitigating your tax hit.
• S corporations – A stock sale may be viable, but the buyer may prefer an asset sale. Working with an experienced wealth attorney can help establish a mutually beneficial plan.
• C corporations – A stock sale is much preferred to avoid double taxation, but the buyer will likely benefit more from an asset sale. Negotiating a stock sale can be easier if you offer indemnifications to protect them from liability issues that may arise prior to the sale.

Comparing Asset and Stock Sales: Which Offers Better Tax Advantages?

The two main ways to sell a business are asset sales and stock sales. Which one is best for your business sale?

Asset Sale

This sale involves the individual assets associated with the business, like equipment, inventory, and intellectual property, rather than the actual company. This can increase the taxes for the seller, as assets are generally taxed as capital gains. This is preferable for smaller businesses that don’t hold significant appreciated assets, which can increase the tax hit.

Stock Sale

This sale of ownership interest in the company, such as LLC membership units or shares. Stock sales are usually taxed as long-term capital gains, and the buyer inherits all liability. This method is particularly preferable for C-Corp shareholders, as they can avoid being taxed as both an individual and a corporation. However, the seller may still be subject to net investment income tax on the sale of a business, depending on their income level.

Contact Us Today to Protect Your Business Sale from Unnecessary Taxes

Selling your business without carefully considering the tax implications can significantly impact your proceeds. The team at 453 Trust Powered by Pennington Law can help you manage your tax consequences and enjoy the hard-earned fruits of your labor. We’re proud to have been recognized as 2024’s Best Deferred Sales Trust Law Firm in the U.S. Contact us today for a free consultation.