Selling a business results in income, and income means income taxes. However, how you structure the sale can make a significant difference in how much of the sales tax you will need to pay and how much you can retain.
Here’s what you should know about selling your business and the tax implications.
There are many moving parts when it comes to selling a business. As the seller, you have a variety of decisions you will need to make. Some of these may be restricted by the Internal Revenue Service. The buyer can also influence some of these decisions, especially considering that their interests may not align with the seller.
There are four tax-related conditions to consider when selling your business:
- Are the proceeds of the sale taxed as capital gains or income?
- Does the sale require payment installations, or is it sold in full?
- Can the sale be treated as a tax-free merger?
- Is the sale a part of assets or a part of stocks?
These issues are related to federal income taxes. Depending on the state you live in, there may be different rules regarding how much tax should be collected.
How Business Sales Are Taxed
The sale of a business is typically not considered a single asset sale in regards to the IRS. With few exceptions, all individual assets regarding the company are treated as individual sales.
Then one must consider if the business assets will be taxed as ordinary income or as long-term capital gains. These can have significant tax implications.
When selling an asset that you’ve had for over 12 months, the sale will be looked at as long-term capital gains. For this, the maximum tax rate is 15%.
If the assets are treated as ordinary income, they will be taxed at the taxpayer’s individual rate. As of now, the top federal income tax rate for individuals is 37%, more than twice as much as the tax rate for long-term capital gains.
As a seller, you may be interested in having as many business assets in the sale as possible to be considered as capital gains to save on taxes. However, this is not always up to the seller.
For example, the IRS stipulates that inventory results in ordinary income, and selling capital assets held for over 12 months creates long-term capital gain.
There is some flexibility between these two boundaries that can reduce the buyer’s tax bill.
Allocation of assets is a significant part of negotiations, and the seller may make changes in terms of the deal or price for an agreeable allocation.
Structure of the Deal
On top of asset allocation, how you structure the deal can impact the tax rate.
For example, if the seller chooses to take the price in payment installations, they can defer paying taxes until the fee is paid. This can mean that buyers may end up paying more when they don’t pay in full. Sellers may also charge interest while saving on taxes.
There is a risk to receiving installments as the new owner must also run the business competently enough to produce profits to make payments. Selling a business has profound tax implications, and it may not be apparent what the best way to minimize your taxes might be. Regardless of the size of your business, you may consider enlisting the services of professionals to ensure the best deal for you. Click neumannassociates.com to learn more.