Family-owned businesses are a cherished American ideal, but it takes a commitment from multiple generations to keep such enterprises going. When the next generation “due up” decides not to step up to take over the business, the company goes up for sale. This was the case with a tax planning client of mine earlier this year. He wanted to retire from the hard, daily grind of running his manufacturing company. But none of his children wanted the business.

So, he had to sell. His company was in good shape and well-situated, so he got a fair price. This was critical, because he and his wife had poured everything they earned back into the company. Typically for most small businesspeople, what they would clear from the sale represented nearly all of their retirement fund.

Which brings us to the biggest issue for this sale: The projected tax bill was hefty, daunting, and threatened to wipe out much of their retirement hopes. Combined federal and state taxes for capital gain and depreciation recapture on the equipment sold amounted to $699,720!  “But wait! There’s more!” cry out the federal and state revenue agents, as they gleefully wring their hands!

For various reasons, the manufacturer had also taken money out of the company over the years, some which he continued to roll over rather than pay back.  This triggered a significant “debt over basis” issue that added to the tax bill.

When the debt to be paid off at close of escrow is greater in value than the Net Adjusted Basis of the asset being sold, that may trigger the debt over basis tax problem. This is a confusing item in tax law and is not triggered in every sale; however, it is an important enough issue that you need to consult your CPA to determine if it applies.

In this case, it did apply…for a second time! He had previously sold his company some years earlier on a seller carry-back financing arrangement.  That is when he learned about debt over basis firsthand and had to pay a substantial amount of tax on it.  That buyer later “ran the company into the ground” and defaulted on his payments. This forced the seller to foreclose and take the company back.  Now, he is selling it again and is very aware that this tax problem could bite him a second time.

In his case, the Net Adjusted Basis was $690,473 with debt of $1,200,000, leaving $509,527 more to be taxed at the 39.6% federal tax rate plus 6.7% for state.  That added $235,911 more in federal and state taxes, leaving his total taxes to pay for selling his business at $935,630!  Having to pay that tax bill would have severely diminished the quality of retirement he and his wife had imagined and longed for!

To manage the tax problem and give them a much better outcome at close of escrow, we successfully combined a monetization loan with an installment sale.  This planning method allowed them to lawfully walk away from escrow closing with NO immediate capital gains taxes due and defer them for decades to come. And they received a tax-free lump sum of money at closing that is nearly equivalent to the amount of the sale proceeds.

Comparing what would have occurred had no planning been done to what was accomplished using this tax- deferral planning strategy, here were the results:

By coupling a monetization loan with an installment sale planning approach to sell the business, he and his wife deferred the taxes for decades and received $785,318 more in tax-free cash at close of escrow. They saved their retirement and benefited, simply by asking the right questions of their financial advising team.

If you have a business or other capital asset that has appreciated in value, when the time comes for you to sell, give us a call and let’s discuss the possibilities available for you.  You have no cost or obligation.  But you do have a great deal to gain.