How to Save Taxes When Selling a Business
Selling a business is a significant milestone, whether you’re ready to retire, start a new venture, or simply cash in on years of hard work. However, without proper tax planning, a large portion of your profits could go toward taxes. Understanding how to save taxes when selling a business and planning strategically can help you maximize your after-tax earnings.
At Molen & Associates, we specialize in helping small business owners navigate the complexities of tax law and structure transactions to minimize tax liabilities. This guide explains how business sales are taxed and offers strategies to save taxes when selling your business.
How Business Sales Are Taxed
When selling a business, the tax treatment depends on the type of business entity, the structure of the sale, and the nature of the assets being sold.
Asset Sale vs. Stock Sale
- Asset Sale: Common for small businesses, this involves selling individual business assets like equipment, inventory, and goodwill. Each asset is taxed based on its classification, which can result in a combination of ordinary income and capital gains taxes.
- Stock Sale: For corporations, this involves selling shares of the company. Stock sales are generally taxed at long-term capital gains rates if held for more than a year, which are lower than ordinary income tax rates.
Capital Gains vs. Ordinary Income
- Capital Gains Tax: Applies to profits from the sale of long-term assets such as goodwill, trademarks, or shares. Long-term capital gains tax rates range from 0% to 20%, depending on your taxable income.
- Ordinary Income Tax: Applies to assets like inventory or depreciation recapture on equipment, which are taxed at your regular income tax rate.
Strategies to Save Taxes When Selling a Business
1. Understand the Tax Implications of the Sale Structure
Work with a tax professional to evaluate whether an asset or stock sale is more advantageous based on your business structure and financial goals. Buyers often prefer asset sales for tax benefits, while sellers often favor stock sales to reduce tax liability.
2. Allocate the Purchase Price Strategically
In an asset sale, the way the purchase price is allocated among the assets can significantly affect taxes. Common categories include:
- Equipment and inventory (taxed as ordinary income).
- Goodwill and non-compete agreements (taxed as capital gains).
Negotiating a favorable allocation can reduce your overall tax liability.
3. Take Advantage of Installment Sales
If you sell your business and receive payments over multiple years, you may be able to defer a portion of the taxes by using an installment sale. This spreads the tax liability over several years, potentially keeping you in a lower tax bracket.
4. Utilize Tax-Free Rollovers
If you reinvest the proceeds from the sale of your business into a similar business or property, you may qualify for a tax-deferred exchange under Section 1031 of the tax code (applicable to certain real property).
5. Plan for Depreciation Recapture
If your business includes depreciated assets like equipment or real estate, be prepared for depreciation recapture, which is taxed as ordinary income. Proper planning can help minimize this impact.
6. Leverage Retirement Accounts
Consider funding tax-advantaged retirement accounts, such as a solo 401(k) or SEP IRA, with a portion of the sale proceeds. This reduces your taxable income in the year of the sale.
7. Use Qualified Small Business Stock (QSBS) Exclusion
If your business qualifies as QSBS, you may be eligible to exclude up to 100% of the capital gains on the sale of the stock under Section 1202 of the tax code. Specific criteria apply, including holding the stock for at least five years.
8. Offset Gains with Losses
If you have other investments with unrealized losses, consider selling them in the same year as your business sale to offset capital gains.
9. Involve Family in the Business Transition
If appropriate, gifting or selling part of the business to family members before a full sale can reduce taxable income. This strategy may also help with estate planning.
10. Hire a Professional Team
Selling a business involves multiple tax, legal, and financial considerations. Working with a tax advisor, attorney, and financial planner ensures your sale is structured for maximum tax efficiency.
Common Questions About Taxes When Selling a Business
Will I have to pay self-employment taxes on the sale?
It depends on how the sale is structured. Income from assets like inventory or equipment may be subject to self-employment tax, while capital gains from goodwill or stock sales are not.
Are there state taxes on the sale?
Yes, state taxes may apply depending on where your business operates. Planning for state and federal tax obligations is crucial.
What if I’m selling a partnership interest?
The sale of a partnership interest is typically treated as a capital gain, except for certain “hot assets” like inventory or unrealized receivables, which are taxed as ordinary income.
Can I deduct expenses related to the sale?
Yes, many expenses incurred during the sale, such as attorney fees, broker commissions, and closing costs, are deductible and can help reduce your taxable income.
How Molen & Associates Can Help
At Molen & Associates, we understand the complexities of selling a business and the importance of keeping as much of your hard-earned profits as possible. Our team can help you:
- Structure the Sale: Evaluate and implement strategies to minimize taxes.
- Plan for Deductions: Identify deductible expenses related to the sale.
- Ensure Compliance: Navigate federal and state tax laws with confidence.
- Provide Year-Round Support: We’re here to guide you before, during, and after the sale.
Why Choose Molen & Associates?
Since 1980, we’ve been helping small business owners achieve their financial goals with personalized tax and accounting services. We combine decades of expertise with a family-oriented approach, ensuring you feel supported every step of the way.
- Tailored Strategies: Solutions designed for your unique business and financial situation.
- Comprehensive Planning: Assistance with all aspects of your sale, from allocation to reporting.
- Experienced Professionals: A team that’s passionate about your success.
Maximize Your Profit When Selling Your Business
Selling your business is a significant achievement, but the right tax strategy can make all the difference in how much you take home. Let Molen & Associates guide you through the process to ensure you get the most from your hard work.
Call us today at 281-440-6279 to schedule a consultation, or visit our website to learn more about our services. Together, we’ll create a plan that helps you save taxes and achieve your financial goals.
