As a business owner, much of your personal wealth is tied up in your business. It makes sense to optimize the sale of your most valuable asset. All too often our firm comes across cases (usually on the other side of the table) where proper planning could have saved the owner thousands of dollars.
From a tax optimization perspective, there are four main areas where you should focus your time, effort and resources. They are as follows:
- Plan for your exit event. Start the planning process at least three to five years before the sale. While you have been operating your business, you may have been focused on tax minimization (which often involves leveraging expenses). As you approach a sale, you should explore ways to position your business to be more attractive to a buyer. What metrics impact company valuations in your industry and what can you do to maximize the valuation? You typically can't make last-minute changes to do much to maximize your valuation, but you can do so over time. Does an employee stock ownership plan (ESOP) exit make sense? For the right scenarios, an ESOP can provide a nice tax-efficient exit option.
- Will it be a sale of assets (more common) or sale of stock? Most buyers want the purchase of assets so that they don't assume any liabilities from prior actions of the business. If you want to pursue the sale of company ownership route, you may have to provide a discount to the purchaser.
Sale of assets will require a price allocation agreement. Some of the income recognized from the sale may require ordinary income for previous depreciation recapture.
Sale of an individual's ownership in a business held greater than one year will result in a more favorable capital-gain tax treatment. Less than a year ownership will result in being taxed at ordinary income rates. Some C corporations that were started during specific periods of time have partial exclusions from capital gains.
- Spreading the money received from a sale has the potential to reduce the overall tax impact by resulting in lower effective tax rates and minimizing high-income surtaxes. However, you have to balance that with the fact that with an installment sale, you will continue to carry part of the business risk until the final payment for the sale is received. What if the buyer fails and destroys the value of the business and underlying assets? What would your recourse be?
- Finally, you need to think about whether you will you continue on with the business for a set period of time. How will that play into your overall tax picture?
The sale of a business is a relatively simple but often involves complex scenarios. My goal today was to highlight some of the tax-related issues pertaining to the sale of a business.
Adam Shay, CPA (N.C. License Number 35961), MBA, is managing partner of Adam Shay CPA, PLLC. He focuses on minimizing taxes and improving the financial results of entrepreneurs, and is actively involved in supporting the Wilmington entrepreneurial and startup community. For more information, visit http://www.wilmingtontaxesandaccounting.com/ or email him at [email protected]. He can also be reached by phone at (910) 256-3456.