When a business owner decides to sell his or her business, there's a lot that goes into the process. In many cases, it starts with an evaluation of what is involved in selling a business versus operating it under new ownership. While selling a business means income, it should be considered that there are taxes to be paid by the business owner as well as the new owners of the business. The following are some of the things that can affect the taxes involved in the sale of a business: Have a question for a tax advisor? Click here.
The proceeds of a business sale are taxed as either ordinary income or capital gains, depending on how the sale is structured. Capital gains shall be applied for business asset sales if said asset has been held for more than one year. The current capital gains tax is at 15%. Otherwise, the proceeds from the sale of a business will be taxed as ordinary income. The maximum income tax rate is currently at 37%. It is a common practice among sellers to treat sales as capital gains in order to pay a lower tax rate. Doing so, however, may result in an IRS audit if done improperly. In addition to finding a qualified buyer and negotiating a purchase price for the business, there are several tax issues associated with the sale of a business: The type of payment structure will determine whether gain should be recognized on the sale of the business. If the whole purchase price is due at closing, then it can be assumed that a lump sum was paid and all consideration would probably need to be reported as ordinary income in the year of sale. If installment payments are made, then capital gains treatment would apply if applicable. However, there may also be alternative minimum tax implications that need to be considered depending upon how much money remains unpaid when compared to how much was initially invested in the business by the seller. A stock transaction involves transferring the shares of a company in exchange for cash, property, or other securities. An asset sale, on the other hand, is the sale of specific assets of a company in exchange for cash, debt assumption, or other assets. Which one is better for tax purposes? It depends. If the business has depreciable assets such as furniture, fixtures, and equipment, then an asset sale would be more advantageous because the buyer can take a depreciation deduction for those items. If there are no depreciable assets, then a stock sale may be preferable because it would be easier to calculate the gain or loss on the sale. The type of entity selling the business will also have an impact on taxes. The most common entity types are sole proprietorships, partnerships, LLCs, and S corporations. The entity type will determine how the proceeds of the sale are taxed. For example, if a sole proprietorship sells its business, the proceeds are taxed as ordinary income on the owner's individual tax return. However, if an S corporation sells its business, the proceeds are taxed as corporate income and may be subject to a double taxation situation. When selling a business, it is important to determine the fair market value of all assets being transferred. This includes tangible assets such as furniture, fixtures, and equipment; intangible assets such as copyrights and trademarks; and goodwill. If the assets have a higher fair market value than the purchase price, then the difference will be treated as a capital gain. If the assets have a lower fair market value, then the difference will be treated as a loss. The income tax rates for both ordinary income and capital gains can vary depending on the state in which the business is located. States also have their own set of rules and regulations when it comes to the sale of businesses. It is important to consult with an attorney or CPA in order to understand how these rules may impact the sale. When selling a business, there are many tax considerations that need to be taken into account. Understanding what these tax considerations will help in negotiating a sale that is advantageous for both the buyer and the seller. Consulting with a professional is the best way to ensure that all tax implications are taken into account. What Happens When You Sell a Business?
How Are Business Sales Taxed?
What Are Some Of The Tax Considerations When Selling A Business?
Payment Made Is All-in or in Installments
Stock Sale vs Asset Sale
Entity Type
Fair Market Value of Business Assets
Income Tax Rates
State Rules and Regulations
The Bottom Line
Tax Considerations When Selling a Business FAQs
The sale of a business may have both capital gains and ordinary income tax implications, depending on the type of asset that is sold and other variables such as length of ownership, cost basis, and gain or loss on disposition. It is important to consult with a tax professional to understand the tax implications of a sale.
Businesses that are sold at a gain will be subject to capital gains taxes, as well as other federal and state income taxes. Depending on the length of ownership and other factors, certain deductions may be available, such as depreciation recapture. It is important to consult a tax professional, as the rules and regulations are subject to change.
Businesses that are sold at a loss may be eligible for an “ordinary loss” deduction, which may reduce the amount of taxes owed. However, the IRS may limit this deduction depending on other factors such as length of ownership and gains or losses on prior sales. It is important to consult with a tax professional to understand all applicable rules and regulations.
It is possible to defer taxes on the sale of a business through certain strategies such as installment sales or 1031 exchanges. It is important to consult with a tax professional to understand the requirements and limitations associated with each strategy in order to make an informed decision.
When selling a business, it is important to have the necessary documents in order to ensure a successful sale. These documents may include a purchase agreement, tax returns, financial statements, asset lists, and legal filings. It is important to consult with an attorney or CPA in order to understand the full scope of documents that are necessary for the particular situation.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
