Tax Considerations of Selling a Business

You’ve reached the finish line.  Congratulations!  The best thing we at Core can do for an entrepreneur is help you negotiate a successful exit.  How you structure the exit can have a dramatic impact on how much you actually receive from the sale.  Although each transaction is unique, and must be considered individually, there are some guidelines to follow when considering a sale of your business.

Sales of business generally are structured as either a stock sale or asset sale.  There are pros and cons to each, both from a legal perspective and tax impact.  It is important to discuss these matters with your legal and accounting advisors before going too far down the negotiation path.

Capital Gains

Currently, capital gains are taxed at a lower rate than other income.  To the extent you can structure a sale to make it subject to capital gains rates, you are going to put more money in your pocket.  In addition to the Federal preferential rate, some states exempt capital gains from businesses located in their states, making the deal even better!

Double Taxation

Businesses structured as C-Corporations need to avoid potential double taxation.  In the event of a sale of assets for a C-Corporation, the business will have to pay tax on the sale, and then the individual shareholders will have to pay tax again when those funds are distributed.  Usually, a stock sale is preferred when dealing with a C-Corporation.

For C-Corporations that have been converted to S-Corporations, any retained earnings from operating as a C-Corporation are subject to taxation when distributed.

Seller Financing

Most sales of small businesses include seller financings, where the seller receives some portion of the sale in cash at closing and carries a note for the balance.  Generally, the IRS allows you to elect to pay the repayment only when you receive it, not at closing.

Each payment is allocated between principal and interest and taxed accordingly.  If the debt becomes uncollectable, you can then write off the balance.

Oddly, if you want to pay the tax at closing instead of as you receive payments, you have to elect to do it.

Consulting

Often times the seller will be contracted for a period of time for transition purposes.  Sometimes the owner is retained as an actual employee of the buyer.  Other times, the seller is retained as a consultant.  This income is usually taxed as ordinary income AND self-employment tax.  This is very tax-inefficient and should be avoided.