David J. Blount, CFP®
LPL Financial Advisor
Selling your business marks a significant milestone in your life, but it also brings tax implications that may amount to a hefty tax bill. As a fellow business owner, I understand the importance of optimizing your sales value while reducing tax obligations. Doing so not only means you’ll get the most out of your hard work, but also provides financial flexibility for your retirement dreams.
Thankfully, there are many tactics you can utilize to accomplish this. In the following guide, we share strategies to sell your business in a way that helps reduce your tax burden while seeking optimized profits. From understanding capital gains tax nuances to valuing assets and mastering negotiation skills, these key strategies pave the way for a tax-efficient business exit and seamless financial transition.
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 0%, 15%, or 20% depending on income level. This sale must be taken into consideration with other types of income you may have throughout the year, so you can plan ahead for your tax bill and pay the least amount possible.
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’s 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 have the ability to depreciate those assets quickly, while the seller wants a lower allocation toward assets in order to reduce capital gains and their overall tax burden. It is also important to understand the order for allocating the 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 aren’t one-size-fits-all solutions, they are ideas you can discuss with your financial advisor and professional team.
Section 1202
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.
Section 1045 or 1045 Rollovers
Under Section 1045 of the Internal Revenue Code, if you sell qualified small business stock and meet specific requirements, you can roll over the gain into another qualified small business investment, deferring the recognition of capital gains tax.
Section 1400Z-2
Similarly, Section 1400Z-2 allows for the deferral of capital gains tax on the sale of Qualified Opportunity Zone Property if the proceeds are reinvested in another Qualified Opportunity Zone Property.
Negotiate an Installment Sale
Another strategy is to structure the deal as an installment sale, agreeing to receive payments for the business over time rather than in a lump sum. This can help spread out your tax liability over a longer period of time, 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’re 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.
Plan for Estate Taxes Expenses
If you’re passing the proceeds of the sale to your heirs, consider estate planning strategies to minimize estate taxes. This may include gifting shares of the business before the sale or establishing trusts to hold the proceeds.
Timing Is Key
Consider the timing of the sale carefully. Start considering your options well in advance of the sale, ideally years before. This allows you to implement strategies that may take time to execute, such as restructuring your business or qualifying for certain tax benefits. Changes in tax laws or economic conditions could impact the tax implications of the sale. Work with your advisors to determine the optimal timing for selling your business.
Use Tax-Advantaged Retirement Plans
Contributing some of the proceeds of the sale to a tax-advantaged retirement plan, such as maximizing a 401(k) or an individual retirement account (IRA), can defer the tax liability. This strategy allows you to invest the proceeds for retirement and take a tax deduction for the year of contribution.
Strategize a Seamless Sale
While there are plenty of ways to reduce your tax burden when selling your business, it’s wise to seek advice from a qualified financial advisor before taking any steps. Every business and post-sale scenario is different, so a personalized strategy for a tax-efficient business sale is key.
If you’re looking for tailored advice to fit your specific situation and financial goals, our team at Investment & Insurance Planning Services is here to make the process as easy as possible. To schedule a complimentary call to discuss your current financial planning considerations or investment concerns and see if our services are a match for your needs, contact us today at service@davidblountIIPS.com or (407) 542-3249. You can also send us a message here.
About David
David Blount is President and CEO of Investment & Insurance Planning Services, LLC (IIPS), an independent and fee-based firm that helps clients establish their financial goals and creates custom financial plans to help them pursue those goals. They specialize in working with pre-retirees, individuals in a career transition, L3Harris engineers, and JetBlue pilots. David’s motivation comes from seeing his clients pursue their goals. He says, “It’s very rewarding to help people make successful transitions from one career to another, start a small business, or retire.”
David received his bachelor’s degree from Troy University, and before becoming a financial planner in 2000, he had a nine-year career in the United States Coast Guard. He obtained the CERTIFIED FINANCIAL PLANNER™ designation in 2007. He has served as the guest financial expert on Orange Television’s Adult Lifestyle Magazine Show and frequently provides financial and retirement planning workshops. Outside of work, he enjoys spending time with his wife, Michelle, their two kids, Ryan and Alana, their dog, Jack, and visiting with friends. An avid outdoorsman, he enjoys fishing, hiking, and exercising, and as a committed person of faith, he enjoys attending church and is passionate about helping people in his community. To learn more about David, connect with him on LinkedIn.
This material was prepared for David Blount’s use.
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Investment & Insurance Planning Services and LPL Financial do not offer tax advice or services.
Comments