Depending on your business valuation, the perceived value of your business can leave you paying a substantial amount of taxes at the sale. That is if you’re not taking the right steps for tax savings.
Here at Consolidated Planning, we understand selling your business is full of unknowns. After all, you’re an expert at running your business, not selling it. With a team of professionals dedicated to helping you realize the full value of your life’s work, you can part ways from your business with a more favorable outcome.
To navigate this fiscal challenge successfully, it becomes imperative for entrepreneurs to explore strategic avenues for minimizing the taxes incurred during the sale. In this article, we’ll delve into three effective strategies that can help you proactively reduce the taxes you pay when selling your business to a third party.
How Do Taxes Differ When Selling To A Third Party?
Generally, selling to a third party means you’ll likely get the majority of the proceeds up front. All at once. This might be 100% but most likely 80%, then the remainder will come within one to two years.
Compared to an installment sale where you might be paid over 10 years, selling to a third party means you’re getting a big check. All at once. This means a drastic increase in income, taxable capital gain, leaving you in the highest tax bracket. And while receiving more money up front is always a good thing, the tax hit can feel worse than an inside sale.
So, what can you do to mitigate these associated taxes?
#1 Finance The Tax Through A Securities-Backed Loan
If you sell your business for 5M, the capital gains tax might be 1.5M. You write that check within a few months – it’s paid in full and you lose use of that money.
Before you pay that tax, you have 5M. If you allow this to sit in a brokerage account, the broker dealer will extend to you a securities-backed loan credit against the 5M. One of the options you might consider here is get this line of credit on the tax you would owe (1.5M), at hopefully a competitive interest rate, and use the borrowed money to pay the tax. This leaves you with the entirety of the 5M that is earning a higher or similar yield to what you’re paying in interest.
Rather than netting 3.5M, you still have access to the 5M. So while you have a loan of 1.5M against it, the gains within the portfolio might pay the interest or even some of the loan off over time.
Financing the tax here puts you in control. You don’t have to rush into paying the tax when you defer the loss of the money.
So while you have to pay the tax on the money right away, you have to use YOUR sale proceeds to do so. This gives you the choice to pay it off when you want. This could be in a few months or a few years.
A chance to yield more than you pay, that’s a win-win.
#2 Combine Your Exit Goals With Charitable Goals
Another way you can work to mitigate taxes is by combining your exit goals with your charitable goals. This strategy has tax savings before, during, and after the transaction.
The most common way to do this is through a Charitable Remainder Trust (CRT). Your first step here is to shift some amount of your stock into this trust. Every time you shift stock into the CRT, you get a charitable tax deduction. For example, by putting 1M of your shares in, you will receive maximum deductions as this amount is more than you are even allowed to deduct.
After you shift some amount of your stock into the CRT, you can derive income off of this. But only up to 5% a year. Then when you or your spouse passes away, the balance of the trust passes onto the charity.
Now, when a third party comes along wanting to buy your company, they are technically buying it from the trust. Because the trust has the qualifying beneficiary, when the trust transacts for the sale, the trust doesn’t pay any Capital Gains tax. That means with the 5M example, there is no tax paid, so 5M remains in the trust. You can then pull 5% off as long as you live, leaving $250,000/year for the rest of your life.
This scenario is a great option for business owners who have other assets or other streams of income where pulling just 5% off a year is enough to fulfill their post-sale income requirements.
If your lifestyle is right for this, you can avoid taxes and do some good in the process.
#3 Leverage Employee Type Benefits
Empowering your employees through an Employee Stock Ownership Plan (ESOP) is another great way to fulfill a social good and receive a tax break.
The beneficiaries of your ESOP Trust are your employees. Here, the trust will borrow money from the bank, say $5M, then the trust will turn around and buy the shares from you, giving 5M cash to the owner. Then the cash goes into the trust with a note to pay off in 15 to 20 years. But, along the way, your employees effectively own the company through the ESOP Trust.
Now your employees own the company through the trust, leaving them with shares to benefit from. Upon retirement they can cash out with a huge benefit to them.
When you sell to an ESOP, and elect for Qualified Replacement Property (QRP) you can avoid paying Capital Gains tax. And as you move forward, the business won’t pay income tax. For example, when you owned your company, 1M in profits left you with $600,000. When the ESOP makes 1M, they keep the entirety of this profit.
While the benefit of the tax savings is vast down the line, there is a good deal of complexity and costs associated with the necessary consultants and attorneys to get this trust up and running.
Sell Your Business And Incur The Least Tax Possible
Selling your business for its maximum value while paying the least tax possible is the name of the game.
But, business owners don’t know what they don’t know. So while selling your business to a third party is a great avenue for actually receiving as much of your sales proceeds up front, the substantial influx of taxable gains can be daunting.
After your business valuation but before you begin any discussions around a sale, it’s essential that you know your options when it comes to controlling your cash flow and options for deferring the loss of money.
To learn more about the taxes you have to pay when selling your business, talk with an experienced professional at Consolidated Planning.
2024-170254 Exp. 2/2026
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
This material contains the current opinions of Neal Brincefield and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
