There are three major players in the sale of a business – 1. Buyer, 2. Seller, 3. Government. Minimizing taxes plays a major role in structuring and negotiating a deal. Many promising deals have fallen through because the buyer and seller couldn’t agree on how to structure the deal to minimize taxes.
If your company is set up as a sole proprietorship or partnership, you will be selling the assets of the company. Although there are some technical differences, the income from the sale of your business will flow through into your personal tax return in a similar fashion as it does now.
If your company is an S-Corporation or LLC Corporation, you can choose to sell either the assets or the stock of the corporation. Because the income flows directly into the stockholders’ personal income in these types of corporations, a stock and asset sale yield similar taxation, so the asset vs. stock decision is usually made for non-tax reasons. If you own an S-Corporation/LLC, you have some flexibility from a tax standpoint in whether you sell stock or assets.
C-Corporations are a tax obstacle for the seller if assets (not stock) are sold. If you are selling a C-Corporation, for all practical purposes you must sell the stock, not the assets. If you sell the assets, the corporation will have to pay tax on the sale, then you will personally pay tax again on the after-tax amount you remove from the corporation. For example, let’s use a combined state and federal tax rate of 40% for the corporation and individual. For each $1,000 in assets sold, the corporation pays $400 in taxes and keeps $600. Then the corporation pays you $600, but you must pay $240 in taxes. You are left with $360 – so the total tax rate is 64%.
While an asset sale is a tax nightmare for the seller of a C-Corp, a stock sale can be a nightmare for the buyer. By definition, the buyer of stock assumes all liabilities of the corporation, both on and off the balance sheet. If a lawsuit that nobody foresaw comes up three or five years from now, it’s the buyer’s problem.
That understandably makes buyers extremely nervous about buying stock. The buyer also loses a lot of tax advantages that an asset purchase carries with it. In an asset sale, assets can be depreciated starting from the buyer’s (high) basis – if it’s a stock purchase, the buyer can only depreciate assets starting from the seller’s (already depreciated and usually low) basis.
Regardless of the legal form of business, there are two tax considerations for all sellers. First is how income is taxed – as personal income or capital gains. With long-term federal capital gains rates at 20% and top personal income rates over 30%, this can be an important factor. The other consideration is when income is earned (and taxable). There are methods (see the articles below) for structuring payments that can help the buyer and seller to work out a mutually agreeable payment structure for tax purposes.
With the importance of tax considerations, your accountant and/or tax attorney should play a major role in helping you plan the sale. A good tax and business attorney in Atlanta is a necessity in selling a business.