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Plan for taxes when selling out The often-overlooked impact of capital gains taxes can spell the difference between a good deal and a bad one Capitalizing on a strong economy and favorable capital gains tax rates, many business owners have decided that now is the right time to sell out. If you’re among them, please heed this piece of advice: Don’t overlook the tax issues related to the sale of your business. Major tax consequences can turn what looks like a good deal into a bad one. Assets vs. stock. From a tax standpoint, one of the biggest questions in selling your business may be whether to sell the assets or sell the stock. If you choose the former, whether the entity is a C corporation or an S and whether it has always been that type of corporation will have significant tax implications for you. Sale of stock. The advantages to you of a stock sale are its simplicity and favorable long-term capital gain treatment, assuming you’ve held the stock for more than 18 months. For federal income tax purposes, assuming long-term capital gain treatment applies, the excess of the amount you receive over your basis in the stock is taxed at a maximum rate of 20%. Your buyer gains control of the corporation in a simple transaction, and you receive favorable tax treatment. If stock is to be sold, an installment sale might be attractive to you and the buyer. The buyer doesn’t have to obtain outside financing, since you’re financing the purchase, and the interest rate you negotiate with the buyer will probably be higher than what you could earn with other investments. More important, in an installment sale the taxable gain is recognized as you collect the payments. Sale of assets. Generally, the sale of assets and subsequent liquidation of the business is not in your best interests. The impact is especially unfavorable if you own a C corporation. Any gain on the sale of assets will be taxed to the corporation, and when the net assets are distributed in liquidation, you will be taxed on the amount by which the proceeds received exceed the stock basis. If you own an S corporation, you avoid the double taxation of earnings (but if your S corporation was converted from a C corporation within 10 years before the sale, you may be subject to additional tax). Nontaxable reorganization. If you meet certain complex requirements, you may be able to sell your corporation tax-free or at a substantial tax savings. There are three types of such corporate reorganizations:
To meet the requirements of a tax-free reorganization, you must end up with a substantial equity interest in the acquiring corporation. The basis of the stock you receive in the corporation that acquires yours is a carryover from the stock of your acquired corporation. You defer the gain until you sell your shares in the acquiring corporation, and you can time that sale to take advantage of favorable changes in tax rates. Asset diversification vehicle. Under an asset diversification vehicle (ADV), you set up a partnership to buy your corporation’s stock. You then form a 20-year charitable remainder unitrust and contribute to the trust a 99% interest in the partnership. When you sell, only 1% of the sale price is taxable. You become liable for further capital gains tax only when the trust distributes the sale proceeds and their earnings to you over the trust’s 20-year life. Intra-family sale. The intra-family sale technique allows you to reduce your capital gains tax liability by selling your business to your children, who in turn sell to the buyer. The children contract to pay you an annuity based on the fair market value of the company for the rest of your life. No capital gain is triggered when the children sell the stock to the buyer. That is because the children are entitled to a tax basis equal to the present value of the amounts they agree to pay to you, as those amounts are paid. This technique enables you to pay your capital gains tax in installments as you receive payments from your children. |