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Understanding the Tax Implications of Selling a Business

If you’re closing or selling your business, you most likely have to pay tax. Here’s a guide to understanding the tax implications of selling a business.

The news is constantly filled with stories of hot startups that burst out of nowhere and are sold a few years later for tens of millions of dollars. For instance, Facebook bought Instagram for $1 billion only two years after the company began.

If you’ve started a business of your own, you’ve probably considered doing the same. Selling a business is a great way to make a windfall of cash while freeing yourself from other pursuits.

But if you think you can walk away from a business sale without Uncle Sam wanting a piece, you’ll be sorely disappointed.

Read on to know what to expect from the IRS when you sell your business.

 

Asset vs. Stock Sale

There are a number of ways that you might sell your business. But most of these sales are either an asset sale or a stock sale.

Asset Sale

In an asset sale, the buyer purchases the company for the price of the seller’s assets. The price of the sale cannot value the business as a single asset. Rather, this price is negotiated through the separate values of each individual asset.

These assets include inventory, equipment and property, and intangible things like trademarks and patents. The IRS figures the gain or less of each asset separately.

Many buyers prefer an asset sale because they can deduct the cost of the business to reduce their tax liability.

Stock Sale

In a stock sale, the buyer purchases the seller’s share of the company’s stock. A price for the stock is agreed upon based on a business valuation. The seller gives the cash value for those stocks.

In a stock sale, the tax requirements favor the seller.

Money earned from a stock sale is considered capital gains. And since income from capital gains is taxed at a lower rate than earned income, a stock sale can lead to a lower tax rate on proceeds from a sale.

 

IRS Allocation Rules

There are no hard and fast rules to determine the exact price of your business. Whether you sell through an asset sale or a stock sale, the value of your business will be determined through negotiations with the buyer.

However, the IRS has guidelines for that valuation.

Per the IRS code, the negotiated price must be roughly equal to the Fair Market Value (FMV) of the companies assets or stock value.

 

Installment Sales

If you’ve been approached by a potential buyer, you’ve probably wanted to learn how to avoid capital gains tax on a business sale.

While you won’t be able to get away without paying some tax on it, there are ways to make your tax liability more manageable.

Many people spread out their tax liability by selling their company in installments. You won’t receive a huge lump sum if you do this, but you also won’t owe the IRS a huge lump sum at once.

Instead, you will spread your tax debt across smaller amounts over several years, which may be more manageable.

 

Need Help Selling a Business?

Selling your company is a huge ordeal. And not just because of the tax liability: there are hundreds of moving parts to keep track of.

And often, it pays to bring in the experts.

If you need help selling a business, contact us today!