You must take a proactive and thoughtful approach to tax planning if you want to sell your business for a top-dollar price. Value drivers such as a motivated management team, an operating system that improves sustainability of cash flow, a realistic growth strategy and effective financial controls all help, but cash flow is one of the key factors that reaps greater value when appraising a business for sale. Effective, long-term tax planning sustainably maximizes that cash flow.
What tax factors impact the gain on selling a business? What obligations can owners be faced with once they decide to sell? Here are just a few to think about.
What is Included in the Taxable Gain Received by the Seller?
The IRS uses terms like consideration, interest and tax basis when a business is sold. Consideration is what the seller receives from the buyer in exchange for the business. These considerations can include cash in business accounts and liabilities from which the owner is relieved (considered income by the IRS). Interest is what the seller owned in the business that was sold. And tax basis, an important figure, is the seller’s original investment and added contributions made in the business.
To determine the tax on the sale, first take the sale price and subtract from it the sale and escrow costs, giving you the net sale proceeds. From that figure subtract the tax basis, leaving you with the taxable gain. A business or stock of the business owned more than 365 days become long-term capital gain and qualifies for a lower tax rate. This applies to most businesses sold.
Planning Ahead Can Pay You Greater Dividends in the Future
Odd as it may seem, the moment you buy or start a business, you must also begin to think about the exit strategy you will use when you decide to sell. Ask yourself, “How can I structure my enterprise to gain the greatest value while running it and also minimize the tax bill when sold?” Start by clearly documenting the investments you made in the business over the years to add them to your tax basis, to lower the taxable gain and raise the net profit you gain on sale.
Look for Preferential Tax Treatments
Planning strategies to capture tax credits and deductions significantly reduce what you owe each year. But, they cannot all be used for every business structure. Certain medical deduction strategies can be implemented for a C-corporation, for instance, but cannot be used for an S-corporation, sole proprietorship or partnership.
How a business is structured can also have a significant impact. For example, if the business is a C-corporation, the sale can trigger a “double taxation” problem where the gain is first taxed at corporate tax rates and then the distribution to the shareowners is taxed again as personal gain. This is not usually the case if the business is an S-corporation, LLC or partnership.
Plan ahead to address these types of concerns to put more profit in your pocket at close of escrow.
The list goes on…
This is, of course, just a short section of a long list of tax planning considerations that you need to navigate in detail well before putting your business up for sale. Other topics might be:
- Federal Net Investment Income Tax
- Tax Treatments of Cross-Border Business Sales
- Timing Considerations
- Wash Sales/Related-Party Rules
- State and Local Tax Considerations
- Estate Planning Considerations
Selling a business can be a complex affair. Start tracking these discussions today with your CPA, and add a qualified tax planner to your team. Begin by improving today’s cash flow by identifying and applying missed opportunities and taxes you may be wastefully paying. This tax-advantaged cash flow will add to your bottom-line over time and improve the value of your business when you decide to sell.
Even if the sale of your business is still years away, you must begin planning for it now.