There are many things to consider when selling a business. One thing that should not be taken lightly is the amount of taxes you’ll owe after the sale is complete. Although receiving a large sum for your business can be exciting, it can also mean large tax bills. Fortunately, there are ways to reduce the amount of tax that you owe.
Capital Gains Tax is the tax levied on a large sale, such as the sale of a property or business. This tax is designed to encourage long-term investments. Business owners pay a lower tax rate if they decide to sell their business more than one year after it is established.
Capital Gains Tax is different than Corporate Interest Tax, which is based on the profits of the business. The length of time the business was owned and the individual’s tax bracket are used to determine the Capital Gains Tax rate.
Often the sale of a business will be structured as an “asset sale” instead of as a direct sale of the entire business. Under this scenario, the business entity remains in the hands of the seller, who will recognize gain or loss on the various components of the business sale rather than the entire interest. Some parts of the sale will be taxed as “ordinary income” which is taxed at a higher rate than capital gain income. This sale structure often gives a better tax result to the buyer, who may be able to write off the purchase at a faster rate than if buying the entire entity. It also often leaves the liabilities (known and unknown) in the hands of the seller.
This type of sale may not be feasible where there are long term contracts held in the name of the business. Some contracts allow for assignment to a buyer, whereas others will not permit assignment. It is important to know the language in your contracts before you engage in a sale transaction.
When selling your business, an Installment Sales Agreement can help reduce the amount of taxes you’ll have to pay. This can be especially beneficial if the amount of profit you’ll receive on your business is likely to push you into a higher tax bracket.
An Installment Sales Agreement allows investors to defer a certain amount of capital gain to future tax years. Under this agreement, the buyer pays a portion of the sales price annually, as opposed to one lump sum. This makes it possible for the seller to adjust their annual income to fit within their financial requirements.
An installment sale can be used for an asset purchase or for purchasing the entire entity. If the buyer and seller agree to an asset purchase, the various components of gain and loss are also spread over the term of the payout.
Burdette, Smith & Bish is a respected tax advisor. We can help you reduce the amount of taxes you owe. Our firm is located in Northern Virginia. We offer tax preparation and planning, as well as consultation and financial support for individuals, non-profits, and businesses throughout the United States, and for citizens living abroad.
Please contact us for more information about reducing your Capital Gains Tax.