By Kevin S. Gray, CEO
Selling a business can be a rewarding experience, but it can also come with a hefty tax bill if not approached strategically. As a business owner, you want to get the most value out of your sale and minimize the amount you owe in taxes. Doing so allows for more financial flexibility to pursue your retirement dreams after you’ve left your business and entered into a new chapter in life.
Fortunately, there are several strategies you can employ to move toward this goal. In this article, we will discuss how to sell your business while reducing your tax liability and maximizing your profits. By understanding the nuances of capital gains tax, valuing your assets, negotiating effectively, and other key strategies, you can take steps toward a successful sale and smooth 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.
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 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).
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 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 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.
Work With a Financial Professional to Implement the Best Strategies
While there are several strategies and tactics you can employ to minimize your tax liability, it is important to consult with a qualified financial professional before making any decisions. The circumstances of your business and your life after business are too unique and complex to rely on a one-size-fits-all approach.
If you’d like customized advice tailored to your business and your financial goals, our team at Veracity Capital would love to help. Reach out to me at 678.888.4952 or Kevin.Gray@veracitycapital.com to get started.
Kevin Gray is CEO at Veracity Capital, and as such he is responsible for the execution of the company’s mission, vision, and success. He excels at working with clients to create independent financial planning solutions and offering guidance to clarify, prioritize, and achieve their goals. Kevin’s broad experience, which includes several corporate leadership roles at previous financial firms, provides him with an array of perspectives he applies to an ever-changing investment market. He’s motivated by the desire to figure out what’s best for each individual client, and he greatly values the trust they have in him.
Kevin has a Bachelor of Science in Agricultural Economics from Texas A&M University and an MBA focused in finance from Southern Methodist University. He was President of the East Dallas Exchange Club, Treasurer for Willow Bend Lakes HOA, member of SMU Cox Business and the Dallas and Collin County A&M Clubs, and is also the Pack 2008 Cub Scout Committee Chair. Kevin and his wife have two sons whose activities dictate much of their time out of the office. They enjoy traveling, golfing, or boating on weekends, and for over a decade, Kevin has maintained a hobby of making his own craft beer. To learn more about Kevin, connect with him on LinkedIn.
Advisory services offered through Veracity Capital, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.