Thinking about Selling Your Business in 2020? Beware of These [Tax] Implications

Chances are when you opened the doors to your small business, you had no exit strategy in place. And now, you want to sell your business.

It’s important to understand that selling your business has significant tax implications. Knowing what you want from your business is critical in determining how you structure the sale and minimize exposure to heavy tax burdens. 

The first step in strategizing the sale of your business should be to enlist the assistance of a tax attorney as your advisor. As a tax planning professional, your Columbia, Maryland tax attorney will explain options for your specific situation; they are best equipped to navigate the cumbersome IRS and state tax codes regulating the sale of your business, determine your after-tax position, and structure a deal that meets your objectives.

Your Greater Purpose. What Do You Want?

Selling the business you’ve worked hard to grow isn’t always an easy decision. For most, there is a greater purpose in letting go than simply having “had enough.”  Perhaps it’s the allure of retirement and more free time with family?  Is it time to travel and live out a new adventure; or maybe it's a giant step in leaving a legacy to future generations, whether as an inheritance provision or a charitable endowment?

Whatever your reason, clearly defining your purpose is critical information for your tax attorney in their efforts to preserve wealth and limit the taxes you will pay upon final sale of your business.

With your “why” defined and your expert tax attorney in place, it’s time to get informed and understand the tax implications of selling your business. 

Use Caution Moving Forward - Take Your Columbia, Maryland Tax Attorney with You

There is one undeniable fact when moving forward with the sale of your business:  you will pay state and federal taxes on the proceeds.  How you structure the sale will determine how much of the profits you keep, and how much you pay in taxation.  Relying on the expert guidance of your tax attorney is critical when considering state and federal tax implications:

Type Of Business Entity

The IRS views sole-proprietorships, partnerships, and LLCs differently from S and C corporations during the sale of a business, with the allocation of corporate stocks a distinguishing factor.  Corporate mergers, reorganization, and stock exchanges can sometimes allow for tax free transactions. 

However, the IRS tightly regulates rules of compliance regarding these occurrences. Changing your business entity just prior to sale simply to avoid taxation of the proceeds will be scrutinized by the IRS, and may carry substantial penalties and challenges. Your tax attorney should evaluate any necessary reorganization and make recommendations well before negotiating the sale of your business.   

Asset Allocation

Asset allocation is the attachment of purchase monies toward tangible assets such as inventory and equipment, or to intangible assets such as intellectual property and goodwill.  Each asset category is taxed as either ordinary income or as long-term capital gains with significantly different tax rates. Generally, a buyer will prefer to allocate funds toward tangible assets which may be immediately deductible or depreciated on their tax filing. 

However, asset allocation of this type means the monies received by the seller are taxable as ordinary income, and at a rate higher than capital gains profits. For this reason, sellers favor attributing a greater percentage of the purchase price to business assets that fall under long-term capital gains, wherein the tax rate is significantly lower. 

“How you structure the sale will determine how much of the profits you keep, and how much you pay in taxation. ”

— Steve Thienel

Buyout Payments

Cash buyouts, seller financing, and installment plans.  Which is best?  Cash buyouts are generally less tax friendly to the seller than installment sales. Cash buyouts expose the seller to taxation on all proceeds in a single year, and generally fall in a higher tax bracket under ordinary income rules.

Seller financing and installment plans such as deferred payments, escrow accounts, and earnout/contingent payments provide the benefit of being able to manage taxation of future payments over various years, although they carry a risk of default by the buyer.

Every buyout option presents federal tax benefits and risks that must be carefully analyzed and prepared during the planning of your sale. Considering the added risks of double taxation by local/ state authorities compounds the challenges of selling your business and reinforces the need for expert tax advice by a competent and seasoned tax attorney.

Plan for your future, prepare for the sale of your business, and contact Columbia, Maryland tax attorney, Steve Thienel today.