If you’re a business owner, even the thought of selling your business can be daunting. Many owners today just focus on getting the proper valuation of their business and finding a buyer that will be a good fit. While these factors are important, there is often an area that business owners tend to overlook: tax planning.
Navigating the tax landscape of selling your business is critical for a prospective business seller. Utilizing all the tools at your disposal, you can help minimize the tax burden at the conclusion of the deal. Having a solid tax planning strategy is an essential part of selling your business.
Strategy #1: Sell to Your Employees
The tax consequences of a sale are impacted by the entity that is buying the business. Many business owners may want to avoid the negotiating process, and they can accomplish this by selling directly to their employees. If an employer’s business is structured correctly, they can sell shares through an employee stock ownership plan. The employees would purchase these shares, and the business owners would be paid out without having to search for buyers.
It is also important to separate capital gains items from ordinary income items of your business before the sale. As a seller, you would rather have sections of your business taxed at capital gains rates, as those will most likely be lower tax rates than your ordinary income. Keep in mind that the buyer will want to allocate as much as possible toward assets taxed at ordinary income, as these items will depreciate in value going forward.
Strategy #2: Understand Deductions & Exemptions
There are a number of ways to limit the tax exposure for the sale of your business. A smart strategy is to keep track of all of the deductions and exemptions for which the business is eligible.
Section 1202 capital gains exclusion is a specific policy that many sellers take advantage of. Section 1202 allows small business owners to exclude at least 50% of the gain realized on the sale of their qualifying small business stock (QSBS) that is held for five years or longer. This gain is capped at the greater of $10 million or 10 times their basis in the stock.
For folks in high tax areas such as California, an incomplete gift non-grantor trust may be in your best interest. This type of structure makes it possible to switch tax jurisdictions from one high tax state to a state with no income or business tax. If this type of structure is created at least two years before the sale, the business owner will be exempt from paying a state capital gains tax.
Strategy #3: Charitable Donations
Another way you can lessen your tax liability is by deducting charitable contributions from your business’s tax return. If you own an S corp with a successful track record, you can deduct up to 20% of your net business income from your income taxes. (1) By donating to charity, you enjoy the dual benefit of supporting an important cause and lessening your tax burden.
The more you reduce the amount of taxes you have to pay, the more successful the sale of your business will be. However, you should consult with a tax professional or advisor who specializes in helping business owners handle their tax situation before selling your business.
We’re Here to Help
These strategies are just a small part of tax considerations for selling a business. There are many other tax strategies you should consider before selling your business. A professional can help you understand these opportunities and take advantage of tax-efficient strategies.
At Grace Wealth Management Group, you will have a team of professionals offering you support. We collaborate with a network of CPAs to help guide you through the decisions you make for your business and your tax situation. We will also help you create financial plans that fit your individual lifestyle. To learn more about how we can help you with the sale of your business, schedule an appointment here or call me at (949) 631-3840 x2 or email firstname.lastname@example.org.
About Jim Peters
Jim Peters is an independent financial advisor and the founder of Grace Wealth Management Group, Inc., a full-service financial firm committed to helping people pursue their financial goals. With more than 24 years of experience in the industry, Jim combines his extensive knowledge with his genuine interest in helping people pursue financial independence. Beyond his experience, he is certified as both a Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®), meaning he has advanced training and knowledge in financial planning and insurance. Based in Irvine, California, Jim specializes in working with individuals, families, and businesses throughout Orange County. To learn more, connect with Jim on LinkedIn or visit www.financialadvisorirvine.com.