Considerations When Buying or Selling a Business
Congratulations! You have put your business up for sale or you are in the market to buy a business. If you are either the seller or the buyer, there are tax considerations that need to be explored. There is some advance work to be done to minimize your tax liability and ways to maximize your profits when buying or selling a business.
Steps to take when selling your business
- Hire the proper professionals with experience to assist in the sale. This should include a certified public accountant (CPA), attorney, a business valuation professional, and possibly a business broker.
- Determine why you want or need to sell and set a sales price. Pricing your business may require getting a business valuation. This valuation will help set your sales price and your CPA can use it to estimate your tax liability. Factors that can affect a business valuation include:
- Profitability of your business
- Completeness of financial records (Financial statements and tax returns)
- Competence of personnel
- Age and condition of equipment
- Customer loyalty
- Understand the tax consequences from the sale of your business. Have your CPA determine if you are liable for ordinary tax rates or long-term capital gain rates. The type of assets that you are selling and how long they have been owned will determine which rates will be used, and can make a major difference in how much you keep.
- Find out about your state’s taxation structure. In addition to federal income tax, most states also tax the gain from the sale.
- Understand what you are buying. If you are buying a sole proprietorship or a single-member LLC, you can only purchase the assets. If the company you are purchasing is a C or S corporation, partnership, or limited liability company, you can directly purchase a seller’s ownership interest.
Our team of CPAs can help you with the following financial accounting and financial statement preparation needs.
Reducing taxes when selling a business
Business owners need to consider many factors in structuring their sale so that they can reduce their federal and state tax obligation. Some considerations should include the following:
- Allocation of the purchase price to capital gain assets instead of ordinary income assets.
- Specify a portion of the sales price to apply to certain business or capital assets, such as inventory, receivables, customer lists, etc. Hot assets are assets that have the potential for creating ordinary vs. capital gains rates. Examples are equipment and inventory.
- If your entity is a corporation (either C-corp or S-corp), try to sell the stock instead of the assets. You will pay tax at capital gains rates (long-term capital gain rates if you held the stock for more than one year)
- Negotiating an installment sale could help lower your adjusted gross income over several years as you will pay tax when you collect the payments. However, depreciation recapture will be taxed in the first year; therefore, make sure that the first year has enough cash flow to cover this amount.
Strategies for minimizing taxes when selling a business
Business owners may follow several strategies to reduce income taxes when they sell their small business or franchise.
- As noted above, ordinary income rates and long-term capital gain rates will affect the amount of tax that you will have to pay. The IRS categorizes business assets into seven classes. Each of these has its own guidelines for acquisition, fair market value allocation, and taxation. Allocating the purchase price based on your company’s asset classes determines capital gains, capital losses, and tax rates. Therefore, to enhance tax savings at time of business sale, allocation should prioritize those asset classes that attract long-term capital gains rates.
- Agree to an installment sale arrangement and get paid over several tax years, rather than a lump-sum purchase payment, which could reduce the overall taxation on the transaction. As part of this strategy, you can opt to do seller financing, wherein the buyer pays a portion of the sales price up front and signs a promissory note with interest for the remaining installments. Seller financing may help the parties close quickly and gives the business buyer better access to capital and better terms, and faster closing times.
- There are other more advanced strategies that may be available to you, however they are much more complex and require much deliberation. Some examples include the use of trusts such as a charitable remainder trust (CRT), or setting up an employee stock ownership plan (ESOP) which gives your staff a stake in the business and the business owners a variety of tax benefits. Another option is to invest into a qualified opportunity zone fund to defer gains.
Items to consider when buying a business
If you are purchasing a business, you will not pay tax on the purchase. In general, the seller is liable for any and all taxes owed. However, you need to be careful that the purchase structure does not transfer any of the sellers’ liabilities to you.
- Hire the proper professionals with experience to assist in the purchase. Just as with a sales transaction, this should include a certified public accountant (CPA), attorney, and possibly a business broker.
- Determine the entity type that the business will be operating such as a sole proprietorship, a partnership or a corporation. Each type of organization has its own issues and challenges and should be reviewed before closing on the sale.
- Buying a business will incur start-up costs and organizational expenses during your due diligence period. Examples of start-up costs are customer surveys, product research, professional fees, site selection costs, etc. Examples of organizational costs are incorporation fees, legal and accounting fees incident to organizing an entity and purchasing the business, etc. Generally, the business will only get a current tax deduction of up to $5,000 when your start-up costs and organizational expenses are less than $50,000 and the remaining amount is amortized over 15 years.
- Allocation of the purchase price to ordinary income assets instead of capital gain assets. This is because the tax write offs will be much faster. Inventory is an expense when sold as compared to depreciating a client list over 15 years.
SSL CPA Can Guide You on Minimizing Tax Liabilities and Maximizing Gains
As seasoned CPAs and business advisors with experience in mergers and acquisitions, and buying and selling businesses of all types, the team at Scheidel, Sullivan & Lanni LLC will review your buy-sell agreement, other transactional paperwork, and accounting records and financial statements.
- Our CPAs will review your personal tax situation and determine how buying or selling the business will affect your tax liabilities.
- If you are buying a company or franchise, we will help you choose the entity type to operate your business.
- If you are selling your business, we will recommend strategies for minimizing capital gains and maximizing profits.
Before you put your business on the market or before you sign that buyer’s contract, contact us for an assessment of your buy-sell strategy.