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Strategic Steps to Selling Your Business While Reducing Taxes

By Sean Condon, CFP^®

Selling your business can be both exciting and daunting, especially when it comes to working through the potential tax implications. As fellow business owners, we understand how important it is to optimize your sales value while reducing tax obligations. Doing so not only allows you a smoother transition as you exit your business, but also provides greater financial freedom to pursue your retirement goals.

This article explores practical strategies to sell your business while strategically creating a tax-efficient business exit. From understanding the complexities of capital gains tax to effectively valuing your assets and mastering negotiation tactics, we cover key steps to help you create a successful sale and transition into your next chapter with confidence.

Plan for and Reduce Capital Gains

One of the primary considerations when selling a business is the impact of capital gains tax. Capital gains tax is a tax on the profits earned from the sale of an asset, such as a business or investments. The amount of tax owed is determined by several factors, especially the duration of ownership. When you sell after owning an investment (or business) for more than a year, you will qualify for the lower, long-term capital gains tax rate, as opposed to the typically higher ordinary income tax rate. Generally, short-term capital gains are taxed at the marginal tax bracket, while long-term capital gains are taxed at a lower rate of 15%, or 20% depending on income level.

Most businesses being sold have been owned for more than a year and should qualify for long term gains treatment, but this is not always the case.  As buyers often dictate the terms and tax results on a sale, make sure any purchase agreement lays out tax treatment on and proceeds and future cash flows clearly.

Understanding Stock and Options Impact

If you own shares or have stock options in your company you need to know how a sale will impact the tax treatment of your stock ownership.   Several types of stock options or shares can trigger various levels of taxation, which is why it pays to plan ahead in regard to exercising incentive stock options (ISOs) or filing 83(b) elections, as described in the linked article.  If you feel that a business sale is getting close to a year away, it can be beneficial to “start the clock” on your holding period of the stock to eventually sell at the preferred capital gains tax rate after one year has passed.

Estate Planning Before a Sale

There is a hefty estate tax upwards of 40% (plus potential state taxes) for assets that could be related to a sale of a business, and upcoming law changed indicated that tax burden is likely to impact far more individuals than before.  If assets from the sale of your business can eventually grow to levels that will be subject to the estate tax, it can be to your benefit to transfer a portion of your business ownership to your heirs.  There are many effective strategies for gifting assets to your family, including Family LLC vehicles or irrevocable trusts. Ultimately, how you plan your estate can have a significant impact on how much your family must pay in taxes.

Valuing Assets

Another key area to determining your tax liability is the assets your business owns. Items like real estate, equipment or machinery, raw materials and supplies, and intellectual property all need to be taken into consideration before you finalize any sale. Each party has a different interest in valuing these assets, so it is important to understand that in negotiations. During the process, the buyer and seller naturally want a favorable basis, respectively. The buyer wants a higher allocation of the valuation listed to assets to increase a higher basis and can depreciate those assets quickly, while the seller wants a lower allocation toward assets to reduce capital gains and their overall tax burden. It is also important to understand the order for allocating valuation of assets, which prioritizes easier-to-value assets (such as cash and deposits held in checking or savings accounts), while pushing down harder-to-value items (like goodwill).

Additional Strategies

In addition to the points mentioned above, there are other strategies that may be a fit depending on your situation and your business. While these are not one-size-fits-all solutions, they are ideas you can discuss with your financial advisor and professional team.

Section 1202 – Qualified Small Business Stock (QSBS)

Section 1202 of the tax code provides an opportunity for small business owners to reduce their capital gains tax liability when selling their business. This section allows for tax exemptions on certain types of small business stock, which can result in significant tax savings. To take advantage of Section 1202, business owners must meet specific criteria, such as having held the stock for at least five years and meeting certain size requirements.

Negotiate an Installment Sale

Another strategy is to structure the deal as an installment sale, agreeing to receive payments for the business overtime rather than in a lump sum. This can help spread your tax liability over a longer period, reducing the amount of capital gains tax you owe in any given year.

Deduct Business Expenses

It is also important to deduct all eligible business expenses prior to the sale of your business. This helps reduce the amount of your total taxable capital gains, and thus lowers your overall tax bill. If you are uncertain what to deduct, work with a tax professional to take advantage of all relevant expenses and confirm compliance with all applicable tax laws and regulations.

Collaborate With a Financial Advisor

Before implementing any tax-minimization strategies, we recommend seeking guidance from a qualified financial advisor. Your business and post-business life are unique, which requires a customized approach rather than a generic solution.

For personalized advice that aligns with your business and financial goals, our team at Windgate Wealth Management is here to assist you. You can reach us by calling (844) 377-4963 or emailing windgate@windgatewealth.com. You can also book an appointment online here.

Perritt Capital Management, Inc. is the registered investment advisor for Windgate Wealth Management accounts
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