Choosing to embark on the journey of selling your business can be overwhelming in and of itself. Let alone the tax aspect of this process.
The good news is, you have options for not only the path you take but also minimizing these necessary taxes.
Here at Consolidated Planning, our team has over four decades of experience guiding business owners through their critical financial decisions. The understanding that comes with honing our craft over this period of time helps us deliver a refined process to align your planning efforts with your financial goals. Our planning services focus on financial strategies, not financial products, and the scope of our work is tailored to your needs and wants.
For what is likely the largest financial transaction of your life – the sale of your business – we know that the tax implications of selling your business are complicated yet critical to grasp. Here, we will help you understand what a sale to an insider looks like, what a third party sale looks like and the taxes you can expect to pay, all to find the right strategy in finding tax efficiencies for the sale of your business.
Selling Your Business via Inside Sale vs. Third Party Sale
There are pros and cons associated with both an inside sale and a third party sale when it comes to your business. However, the taxes you will have to pay vastly change based on which path is viable for your business.
We find that while interest rates and economic conditions change whether or not there is a willing buyer or seller, most businesses below 10-15 mil, tend to be inside sales.* Anything above tends to be an outside sale. That’s because higher interest rates make it harder to get loans, making third party sales less viable.
INSIDE SALE
An inside sale refers to selling your business to someone you likely already know – a family member inside the business, a key employee or key employee group inside the business, or through an Employee Stock Ownership Plan (ESOP).
Generally, those being considered for your inside sale don’t have the money to purchase your business. While they can get a bank loan, regardless of whether interest rates are high or low, most banks will make the SELLER guarantee the loan.
Yes, you will have to guarantee the bank loan of your buyer. Putting you on the hook for more than just taxes, if something goes awry. For this reason, most sellers aren’t interested in the buyer using a bank loan.
So instead of a transitional bank loan, an insider usually finances the purchase of the business using a note payable from the buyer to the seller. Therefore, the majority of the purchase price is owed in installments to you over time – as an installment sale.
Following advice from your trusted CPA, the capital gains will be spread out based on the dollars received from the installment sale. Now, as the seller, here are the potential taxes applicable to an inside sale:
- Federal Capital Gains Tax: Generally 20%, based on today’s rates – payable by the seller.
- State Capital Gains Tax: Typically 4 – 5.5% as a range, but based on the state you’re personally domiciled in – payable by the seller.
- ACA Tax, aka the ObamaCare Tax: A tax of 3.8% on business sale transactions – payable by the seller.
- Tax on the Note Interest: When using an installment note sale, an interest rate will likely be charged on the note – the interest paid on this note is taxable to the seller.
So let’s think about this. Before the sale the seller was paying the income tax on profits but after the purchase, the buyer now pays income taxes on the company profits.
As those profits are received by the buyer every year of the installment sale, there are essentially three to four additional taxes paid every year – the taxes described above.
Before a business owner sells their business to an insider, they are taxed just once on its ordinary income. After the sale, that same dollar of earnings is taxed MULTIPLE times.
That said, selling the company to an insider already with the company is often preferred when trying to maintain company culture, reward employees, keep the business in the family – or all of the above.
THIRD PARTY SALE
A third party sale is where you’re selling your business to someone you often don’t know, outside of the business. The taxes involved with third party sales are pretty straightforward and easy, compared to an inside sale. Here, closing is an exchange of company stock for cash at closing.
With that said, there is often a low tax basis for the business stock being sold – approaching zero, meaning if the value of a sale is 10M, the taxable gain is also 10M.
This taxable gain is great for the value of your business but then comes the fun part…paying taxes on that gain. Just like with an inside sale, you can expect to pay the (3) components of the capital gains tax:
- Federal Capital Gains Tax: 20%
- State Capital Gains Tax: 4 – 5.5%
- Obama Care Tax: 3.8%
But that’s it!
Optimize Your Tax Efficiencies When Selling Your Business
As a business owner, considering the sale of their business, you shouldn’t have to spend time and energy keeping up with the complexities of ever-evolving tax implications when it comes to that sale.
We know that selling your business can be a huge source of stress for business owners. And with adequate planning time, some of that stress can be reduced. Additionally, with the right experienced professional on your side, there are options to minimize these taxes at the sale, including:
- Charitable Planning and Charitable Trusts at of business stock
- Gifting the business, especially to family members inside the business
- When selling to an insider, finding a way to lower the value of the business legitimacy and intentionally may be smart, especially when selling to a family member.
- A properly structured ESOP
For those business owners seriously considering the sale of their business in the next 5-7 years, talk with a team member at CP about what can be done to keep your key employees in place and your business’ value on track.
*For the purpose of this article, we will assume the business is not a C-corporation
2023-164962 Exp. 11/2025
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
This material contains the current opinions of Andy Brincefield and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
