There’s a lot that goes into selling any business. From planning everything to finding a buyer to dealing with all the paperwork. Of course, you also need to consider your employees and how to break the news to them. Most importantly, you must consider tax considerations carefully before making any move. No matter what kind of business you plan on selling, taxation is something you need to think about before the sale. So, to help you out, we have put together a list of tax considerations when selling your small business, which you need to think about before going through with it carefully, and we hope you’ll find it helpful.
The basics of small business sales
There are many things to consider when it comes to taxation and selling a small business. There are many moving parts, and you need to understand them before selling your business. Still, four main concerns come to mind:
- Whether the proceeds are viewed as capital gains or as ordinary income.
- If the sale is in installments or if it’s an all-cash deal.
- If the sale is an asset sale or a stock sale.
- In a deal between corporations, if the sale is considered a tax-free merger. Of course, this is related to federal income tax. Certain states may have different rules and collect more or less.
All of this highlights the need to develop an exit strategy for your small business well ahead of time, as it’s much more complicated without it.
How business sales are taxed
When it comes to taxation, the sale of a business is not considered a sale of a single asset. Instead, individual assets are regarded as if they’re sold separately, with only a few exceptions. Then, you need to think about whether the sale will be taxed as long-term capital gains or as ordinary income. The difference between the two is huge, so you must consider them carefully. When selling an asset you’ve held for longer than a year, the proceeds you get from it are treated as long-term capital gain, and the maximum tax rate on such assets is typically 15%. On the other hand, proceeds treated as ordinary income are taxed at an individual taxpayer rate. Currently, the highest personal federal income tax is 37%. This might lead to relying on tax relief, and you should connect with experts if you ever need it.
Negotiate everything when selling a sole proprietorship
If the business you’re selling is a sole proprietorship, then the sale is treated as if you sold every asset separately. Most assets trigger a capital gain, which means they’re taxed at a favorable rate. However, when it comes to inventory of sale and similar assets, they are considered as producing ordinary income. This means that it’s up to the involved parties to negotiate the terms of a sale. Including the price of purchasing these assets, of course. As such, you should carefully look into the exact assets you need to allocate a price to during a sale, plan, and negotiate for everything you can. In addition to your research, however, consider how you can increase the value of your business before you sell. Since you’re selling your small business, you might as well plan ahead to get the most out of it.
How the deal structure might affect taxes
In addition to negotiating everything, you need to consider whether the sale will be in installments or not. We always recommend selling in installments for one simple reason: the seller can defer paying taxes until the payments are received. Experts from consumeropinion.org note that most people consider this a great deal in the long run. This is one significant benefit of selling in installments, but not the only one. From a pure business viewpoint, you can get more out of the sale by selling in installments. Buyers are willing to pay more in the long run than how much they’d have to pay upfront. As such, if you’re patient, you can get a lot more out of the deal. That said, selling in installments is risky, as the buyer would have to run the business well enough to pay.
Considering corporate stock sales
When it comes to sole proprietorships, LLCs, and partnerships, you should treat each as sales of separate assets. When selling a corporation, however, the sale can be presented as a sale of stocks instead of assets. This is very important since if a corporation sells its assets, it would be taxed twice. Once when paying taxes and the second time when shareholders file individual returns. On the other hand, a stock sale is only taxed once, which saves the seller a lot on taxes. However, buyers typically want an asset sale since it leads to more opportunities for depreciation deductions, which opens another area for negotiations between the buyer and seller. Understanding this is important before going into such negotiations, so prepare yourself properly before making a deal. Additionally, before starting the process, you’ll want to understand what due diligence means during the sale of a business.
Tax considerations when selling your small business – wrap up
The taxation of a small business sale depends entirely on what sort of entity is being sold. The difference between selling a sole proprietorship, LLC, or partnership and selling a corporation is massive. However, keep in mind that it also depends on what kind of entity is buying the business as well. Also, it depends on what assets are included in the sale and how the deal is structured. There are many things to think about before even starting the sale of your small business. We hope this list of tax considerations when selling your small business helps clear up some confusion around the topic.