Taxes on the Sale of Your Business

 

Selling your business is a taxable event, the amount of tax that you may have to pay will depend on a variety of factors specific to the business, its location and its owners.   Prudent sellers will take into consideration the tax impacts of the sale at the outset.   Brokers.Law’s team of dedicated professionals are experienced in the legal, accounting and tax implications of the sale or purchase of your business.  The following are Factors that may impact your tax liability on the sale of your business include:

 

• Is the Business a Corporation or pass through entity 

  • ​The entity structure will determine whether there is tax due on the sale, whether it is taxed at the corporate and personal level and how the tax is allocated among the shareholders.   Sellers ideally prefer a structure that will allow for the entire sale to be taxed as long term capital gain.

 

• Will the gain on sale be treated as Ordinary Income or Capital Gains or a combination of both.  

  • ​​Long-term Capital Gains are generally taxed at a lower rate than ordinary income for most owners so tailoring the transaction to take advantage of available tax strategies is a key component for most sellers.  ​

 

• Is the sale an Asset Sale or a Stock Sale

  • ​Because of the tax consequences, most sellers will prefer a stock sale, whereas Buyers will usually prefer an Asset sale.  However, if properly structured, an asset sale can have favorable tax consequences to the seller.  In a stock sale, the original company will continue in existence and continue as a reporting entity.  Asset sales are generally cleaner from a liability standpoint as there is a clear demarcation between the old business and the new business with the new business not inheriting the liabilities of the prior acts of the company.   

• The Adjusted Basis of the Assets being transferred

  • ​In an asset sale, for example, if significant Assets are being transferred to the new owners, the selling owner may have taken significant depreciation deductions on their taxes during the life of the business, this will reduce the adjusted basis of the Selling Business and assets as there may be depreciation recapture on the sale of the business.

 

• Where is the Business Located?   

  • ​Businesses located in jurisdictions that have state level taxation may result in taxation of the sale of the business at both the State and Federal level.  Businesses located in tax friendly jurisdiction may only be taxed at the Federal level.

 

• Whether the Sale is an installment sale or lump sum payment

  • ​Is the selling owner receiving their compensation at the closing or are they receiving compensation in installments or even through an earn-out agreement?   If all of the compensation is received at one time the tax implications will fall in one tax reporting period.  Except with respect to depreciation recapture, installment sale income is recognized as income is collected.

 

• Seller Financing - Interest As a Component

  • ​If the sale is partially an installment sale, a portion of the income may come in the form of interest on the amounts that are due under a promissory note or other Seller financing.   This will, of course, be taxed as received by the Seller, not at the time of execution of the Installment Note. 

 

• Are the owner or owners of the business under a Non-Compete Agreement

  • ​Compensation received for a Non Compete Agreement will generally be taxed differently (for both the Seller and the Buyer of a Company) than compensation for the assets of the Company.   The amount that is allocated to the Non-Compete Agreement will usually be negotiated between the parties.  

​

• Is the Owner of the Business receiving stock or cash or a combination of both?

  • ​Pure cash transactions are simpler than stock and cash transactions as oftentimes stock components will vest or accrue over time and be subject to other restrictions such as vesting and profitability all of which will affect the tax and the timing of any tax due. 

​

• Agreement on the Allocation of the Purchase Price of the Business

  • ​In an asset sale, the Buyer and Seller of a Business will negotiate how the purchase price of the business will be allocated.  The Buyer of the business typically wants as much of the price to be allocated to items that can be deducted from their taxes as soon as possible.  For example, allocation of the purchase price of a business for certain may be deductible in as little as 1 year whereas allocation to Goodwill will be deductible over 15 years.    

 

• The Tax Position of the Selling Owners

  • ​The Seller of a Business may have long term capital losses or other losses that can be offset by the gains on the sale of the Business.   While this is strictly not the tax due based on the sale of the Business it may be a key factor for a specific Seller on the price and timing of the sale. 

 

• Reserves for Indemnification to the Buyer or third party or other liabilities such as litigation 

  • ​The Seller may be able, depending on their reporting on a cash or accrual basis to take reserves for certain contingent liabilities or matters they are indemnifying the buyers for.  This affects the timing of any taxation. 

​

• Compensation that is held in Escrow will usually be taxed when received by the Seller

  • ​If, as part of the Compensation, a third party is escrowing a portion of the consideration on the sale of the Company, you will usually only be taxed on this portion, when and if it is received by the Seller.  This again amounts to a timing difference contingent on the parameters of the Escrow Agreement

 

• Compensation taken by the Selling Owner over time as Consulting or other Income

  • ​Occasionally, it may make sense for a Selling owner to be under contract to the new Company or to the new owner and receive a portion of the compensation for Consulting or regular employment.  Although generally not favored, this can be used to spread the tax impact over multiple years.   

The Tax impacts of the Sale of a Business are specific to the business, the location, the owners, the buyers and the specific terms of the deal, including earn out agreements, escrow, hold back agreements, installment sales and indemnification agreements between the parties. The tax consequences can often be a driving force in structuring the sale of the business and will usually require coordination between the tax and legal advisors as well as the Buyers and Sellers of a business.