Understanding Tax on Selling a Business
The sale of a business has a few layers from the standpoint of both buyer and seller. First, a seller wants to know: how do I price my business? Who do I sell it to? And what is the market rate for a business like mine? Then, the needs of the buyer: how can I project future profits, how much can I write off in taxes, and what assets will depreciate in the business over time? Lastly, there are tax considerations. Tax rules for businesses are complex depending on whether the business is set up as a corporation or a partnership. But some basic tax principles are easy to learn about the successful sale of a business.
Tax on Selling a Business: An Introduction
Project Equity cites that 6 out of every 10 business owners plan to sell their business within the next decade. Understanding the tax impact of your decision to sell is a major part of understanding profits and how those are classified.
A business owner should start thinking about his or her business as a collection of smaller assets rather than as one large entity. An example of an asset is anything from a stock investment to a piece of land or equipment. Businesses are collections of assets that are taxed separately dependent on their category or type. Working with a CPA or tax advisor will help you clarify these specifics, but here are some general principles to follow when thinking about selling your business.
Understanding Your Business Taxes
The IRS doesn’t see your business as one asset. It views each asset you own in separate classes for the purposes of taxation ie. (land, vehicles, property, inventory, and intangibles like trademarks and licenses). This means that one tax rate doesn’t necessarily apply to all assets in your business. Some business assets when sold will be taxed under an ordinary tax rate while others will be taxed under a long-term capital gains tax rate.
A capital gains tax is when an asset has realized a value higher than its original purchase price, as in the case of a business, or land, or a share of stock. The increase in that value, or appreciation of the asset, is then classified as capital gains. Capital gains are earned on an asset you have owned for 12 months or longer. The length of time a business is owned and the tax bracket of the individual is used to calculate capital gains tax rates. Any asset you have owned for less than a year is not eligible for capital gains.
Capital Gains Tax on Selling a Business
One incentive for entrepreneurs who want to sell a business investment is that a capital gains tax rate is lesser, generally speaking than a standard income tax rate. The average individual pays no more than 15 percent on capital gains taxes.
From a business standpoint, however, it depends on how the sale price of the business is structured. If your business is categorized as an “asset sale” rather than a sale of the entire entity, this may prevent the profits from the sale from pushing the business owner into a higher taxation threshold, thus preserving some of the sale profits. There are also perceived advantages to the buyer, for example, if some of the liabilities are still retained by the seller with this structuring of a sale.
Capital Gains Tax: Important Considerations
Asset allocation is an important step in the negotiation between buyer and seller. How the business assets are allocated for tax purposes has implications for both sides of the negotiation. However, determining gains and losses on each asset of your business is not always up to the seller. The IRS has guidelines on how to allocate assets to determine the purchase price. If you do not have the help of a professional CPA, it is recommended to loop them in on your plans to sell so they can advise the best way to organize the assets and strategies of the sales arrangement for the best possible outcome. In some cases, a buyer can also propose adjustments to the purchase price of the business or make specific changes to the tax structuring of the sale to allow for more agreeable tax outcomes for the seller.
Selling a Business with Coachwell’s Support
Gaining a financial picture of the sale of your business is one thing, but dealing with the management implications of selling your business is another. A business advisor who is steeped in the secrets of a good sale can negotiate better outcomes for both the buyer and seller. The process of selling a business can take upwards of six to 12 months, depending on the specifics of the agreement. This means a seller is in it for the long haul and needs the right pieces to fall into place.
Whether you want to sell your business to a competitor or a family member, there are always legal and financial thresholds to navigate. The profit, the part that most owners think about the most, is the very last step to having a successful sale. The circumstances around each sale are unique and require excellent communications skills and business savvy.
Consider getting a business coach to help navigate the sale of something you’ve worked hard to create for the right buyer. A business consultant guarantees the client enjoys a business sale with a clear structure and timeline. Using decades of experience and the right data, a business coach provides peace of mind to the seller that a professional is guiding them through each step.
