As the owner pursuing the sale of your business, it’s key to recognize when you receive offers for your business, the headline number is just that – the headline number. You still have to pay taxes, so having a strategy to minimize your tax liability is key.
While some business owners have great tax advisors and wealth planners in place before they market their company for sale, we also see transactions where the seller waits until they have offers in hand before they discuss their tax liability with an advisor. In a perfect world, a business owner will run multiple valuation structures by their tax advisor before they go to market so there is clear understanding of what the potential tax consequence looks like, early on.
So, how should a business owner consider that headline number when it comes to tax liability?
- Look at all facets of the offer.
Are you looking at an all-cash offer? Is there earn-out or a seller note? Will you be rolling over equity and retaining a stake in the business? Is there a consulting fee? These are all important as they are not all taxed the same way. Ideally, you structure your transaction to have as much of your proceeds taxed at long-term capital gains rates instead of at ordinary income. In addition, if there is an earn out or other contingent payment, you won’t pay tax on that until the tax year it is earned and received. If you are rolling over a stake in the business, ask your tax advisor to review scenarios where you defer paying tax until you cash out.
- Recognize the difference between a stock sale and an asset sale and how it affects tax liability.
Often an asset sale carries higher tax consequences for the seller because they are on the hook for any recapture of depreciation. You’d expect the easy solution is a stock sale, however, buyers often hesitate to proceed with a stock sale because they are assuming a higher level of liability. Determine if there is a way to bridge the gap between the buyer and seller – will the seller agree to an asset sale if the buyer makes them whole on their additional tax liability for recapture of depreciation?
- Allocation of purchase price is important.
Upon closing, buyer and seller must agree how to allocate the assets that are transferred in a sale. Buyers prefer to allocate as much of the purchase price as possible to assets with a short life (i.e. inventory and receivables), because they can be written off in a shorter period (unlike goodwill that has a 15-year amortization schedule). In addition, fixed assets (equipment) are subject to recapture of depreciation if the allocated amount is higher than the seller’s current basis. This means seller will be assessed a tax because they got the benefit of depreciation that the buyer is now going to take. Since both parties can’t get the same tax benefit, the seller will have to report this gain and pay tax on this recapture.
- Understand “other taxes” you may be responsible for.
If you’re a C-Corporation that converted to an S-Corporation, determine if you fall in the recognition/look back period (currently at 5 years) that requires you to pay additional BIG (built-in gain) tax. This is a heavy tax consequence. If you’re close to being out of your look back period, consider holding off on a sale until you are outside of that window. There are also state-specific taxes or special taxes (i.e. Net Investment Income Tax) that you need to review with your tax advisor.
- Do your estate planning first.
Discuss your estate goals and work with your wealth advisor to determine the best plan for your situation.Are there trusts that should be set up before you contemplate a transaction?Get your “tax planning house” in order before you go to market.Completing a transaction requires heavy lifting and many tax planning strategies require time and thought to get them set up properly.
Uncle Sam will get his cut when you sell your business. Be proactive and take the appropriate steps early to make sure you’re setting yourself up to maximize your proceeds and minimize your tax liability. A little planning can go a long way.
If you'd like a recommendation for some outstanding tax advisors, please reach out. We work with great advisors all the time and are glad to make a referral.