“In this world nothing can be said to certain, except death and taxes.” – Benjamin Franklin
Tax Consequences of Selling Your Business in South Florida
Nobody wants to pay taxes, but knowing a little about the tax law and how to minimize your taxes comes in very handy when it comes to selling a business. Business owners should be generally informed about the tax laws and consequences regarding the sale of businesses. Every seller of a business should of course review their own unique tax situation with their accountant. But here are some tax issues that every principal owner of a business should confront before selling their business.
Long Term Capital Gain Tax When Selling Business
When selling a business, the general rule of thumb is that the maximum rate will be 20 percent in accordance with the long term capital gain tax rate now in effect. This 20 percent rate is taxed on the net capital gain, not the gross purchase price of the business. The net capital gain is derived from subtracting the capital basis of the business from the gross proceeds of the sale (net of broker fees). For example, a business that for $500,000 after broker fees but has a $200,000 non-depreciated capital basis (this generally includes the original purchase price of the business when the seller bought it, start up costs, or other capital costs that the seller incurred) at the time of sale, then the net capital gain would be $300,000.
Sellers Sometimes Confused About Capital Gains Tax
Many sellers are confused by the final capital gains tax they are responsible for paying. They think the 20 percent rate simply applies to the purchase price and this is not necessarily true (usually it is not true). The capital basis must be computed, and the seller of a business must explore this issue with their accountant prior to the sale. The higher the capital basis, the lower the net capital gain.
Tax Consequences of Allocation of the Purchase Price in Business Sale
- The sale of a business (when using the typical asset purchase form of sale) for tax purposes is really the sale of individual assets of the business (such as goodwill, the non-compete, inventory, leasehold improvements, or tangible assets).
- The purchase price – by agreement between the buyer and the seller – must be allocated for tax purposes among the individual assets of the business.
- In general, sellers want more of the purchase price to be allocated towards intangible assets such as goodwill, which is taxed at the lower capital gains tax rate.
- Other asset categories may result in the seller facing the higher ordinary income tax rate on that allocated part of the purchase price.
- Buyers will want the allocation of the purchase price to be for assets with the shortest depreciation schedule because then they can depreciate such assets more quickly.
- However, difficulties may arise.
- For example, the shortest depreciable asset is for fixed fixtures and equipment (seven years).
- This sounds great for the buyer, but this asset category may involve state sales taxes.
- Also, when it comes to allocating the purchase price for inventory, both parties must insist that the buyer has a valid tax certificate at the time of sale or else the inventory may also be subject to state sales tax.
When Seller Stays After the Sale of the Business
Some buyers of businesses want the seller to remain on board after the sale as a consultant or as an employee. Such buyers may wish to pay the bulk of the purchase price in the form of these post-closing consultancy fees, rather than as a part of the purchase of the business. Sellers should beware of such proposals, even though it may seem tempting to defer their tax liability. This arrangement does not guaranty that the seller will actually receive fair value for their business.
Seller’s ‘Consultancy Fees’ Also Taxed at Higher Rate
Buyers seeking to pay the seller ‘consultancy fees’ rather than the purchase price in cash at closing generally desire to defer payments as long as possible in order to minimize risk and keep the seller’s ‘skin in the game.’ The problem for the seller, as far as the tax consequences are concerned, is that such consultancy fees are taxed at the much higher ordinary income tax rate (as opposed to the long term capital gain tax rate). So barring unusual circumstances, this is not usually a good idea for the seller.
Maximize Your Overall After Tax Gain for the Sale of Your Business
Always consult a tax expert prior to the sale of your business. The important part of selling your business is to maximize the net purchase price (after taxes!) and to sell the business in a non-disruptive and confidential manner.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a free evaluation for your business.