Maybe you're ready to retire, pass your business on to your children, and live out your days on a Caribbean beach. (Nice choice.) Or maybe you're so far in the black that the time is simply ripe for you to cash out and move on to other endeavors. Whatever the reason may be, you've decided to sell your business, you even have a buyer lined up — and now you have tax considerations to contend with.
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 currently hovering around 20 percent and top personal income rates over 30 percent, this can be an important factor. The other consideration is when income is earned (and taxable). There are methods for structuring payments that can help the buyer and seller work out a mutually agreeable payment structure for tax purposes.
If your company is set up as a sole proprietorship or partnership, you'll be selling the company's assets. When sold, these assets must be classified as capital assets — depreciable property used in the business, real property used in the business, or property held for sale to customers — which results in capital gain or loss. Inventory sale results in ordinary income or loss. All 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, you can choose to sell either the assets or the stock of the corporation. Because income from S Corporations flows directly into stockholders' personal income, stock and asset sales each yield similar taxations. If you own an S Corporation, you have some tax flexibility when considering whether to sell stock or assets.
If you'll be selling a C Corporation, odds are you you'll be selling stocks, not assets. If you were to sell the corporation's assets, the corporation would have to pay tax on the sale and you would personally have to pay tax a second time on the after-tax amount you remove from the corporation. This, as you can readily see, is not a sound financial option.
Structuring the Transaction
In any business sale, there's always a third party with a significant financial stake in its outcome — the government. As both parties understandably seek to minimize their share of taxes, many promising deals have fallen through because the buyer and seller couldn't agree on how to structure the transaction.
When attempting to structure a deal for tax purposes, it's in your best interest to seek the guidance of a professional tax advisor. In addition to saving the shirt on your back, this professional will also help you consider the consequences of the transaction for your employees and other service providers.
Section 1244 stock
If you're selling a corporation as the original shareholder, your stock may qualify as §1244 stock. A §1244 stock qualification allows you, if you're selling your stock for less than your basis, to deduct up to $50,000 ($100,000 if you file a joint return) in a single year. If the loss you take from the sale of your stock is greater than your total income, you may have a net operating loss, which would allow you to carry the loss back an additional two to five years.
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 professional tax advisor is a necessity in selling a business.