This information is derived from Rehmann’s Private Client Advisory (PCA) experience, a uniquely tax-aware approach to growing and protecting wealth through a team of specialists curated for each PCA client’s needs.
Congratulations. You’ve made it to the long-awaited final article of the Mind Your Business series, where we finally tackle the topic that propels most business owners to read up on business transition and succession planning in the first place: selling your business.
Curious why we’ve elected to save our advice and insights about this alluring milestone for last? If you’ve read each of the preceding articles carefully, you probably have an inkling. (And if you’ve flipped ahead, we’ll tell you anyway — if only to compel you to click back and check out what you’ve missed.)
We’ve saved the subject of selling for last because even if it was your first and foremost goal when you began this series, by now you’ve learned enough about the multiple interconnected parts of exit planning to know that selling is neither a simple nor even the final milestone in your financial journey.
Like passing your business on to your heirs, selling it is the culmination of years of your hard work, dedication, and thoughtful, strategic planning with the expert guidance of an integrated advisory team. But it is also something else: the beginning of the next chapter in your life — be that retirement, a new career, the launch of your next business venture, or other personal goal.
Nevertheless, most business owners looking to sell tend to look at the selling price of their business as the end-all, be all. That view, however, fails to account for a crucial factor that can mean the difference between a lucrative and disappointing financial outcome: taxes.
Taxes play an enormous role in determining how much of your sale proceeds you actually get to keep. Understanding the tax obligations associated with selling your business — and planning accordingly — is crucial to your ability to minimize liabilities and maximize proceeds from the sale of your business.
In this article, I’ll provide you with an overview of the key tax considerations you’ll need to make informed decisions and ensure you’re prepared when the time comes to sell.
Why Taxes Matter in a Business Sale
While a high sale price may feel like a win, taxes can significantly eat into your proceeds if not carefully planned for. Various factors, including capital gains taxes, the structure of the sale, and the type of sale all have a direct impact on your final financial outcome. Understanding these factors and working with experienced advisors can help you protect your earnings and minimize potential surprises.
Below, we’ll take a closer look at some of the major tax-related considerations every business owner should understand.
1. Capital Gains Taxes
When you sell your business, the profits you earn may be subject to capital gains taxes. These taxes are typically levied on the difference between the price you sell your business for and your original investment or “basis” in the business.
There are two types of capital gains taxes to consider:
Short-Term vs. Long-Term Capital Gains
- Short-Term Capital Gains: If you’ve owned your business for less than a year and sell it, the profits are taxed as short-term capital gains. These gains are taxed at your ordinary income tax rate, which can be significantly higher.
- Long-Term Capital Gains: If you’ve owned your business for more than a year, profits are subject to long-term capital gains tax rates, which are generally lower and more favorable.
Federal and State Implications
In addition to federal taxes, there may be state and local taxes applicable to sale transactions, which can vary widely by location. It is essential to understand both federal and state tax rates to accurately estimate your tax obligations. Having a financial advisor and tax professional as part of your team early in your business transition and succession planning process will enable you to explore and implement strategies for minimizing your overall tax liability.
2. Asset Allocation
If you read article 3, you know that regular valuations help you understand the value of your business assets as your company evolves and help you make informed decisions about when and how to sell your business.
When the time comes to sell your business, the way you allocate the sale price across your business assets can significantly impact the taxes you owe. Once again, you’ll want to work closely with your tax advisor to ensure an optimal allocation strategy, but for now, it’s worthwhile to understand that the purchase price is typically divided into categories such as equipment, real estate, intellectual property, and goodwill. Each category is taxed differently.
Asset Categories and Their Tax Implications
- Tangible Assets (e.g., equipment, furniture): These are typically taxed as ordinary income, which can result in a higher tax rate compared to long-term capital gains.
- Real Estate: If your business owns real estate, the sale of these assets may be treated differently and could benefit from long-term capital gains tax rates. If real estate has been depreciated, the seller may need to pay depreciation recapture tax.
- Intangible Assets (e.g., intellectual property, goodwill): Goodwill, which represents the value of your brand or reputation, is often taxed at long-term capital gains rates, making it more favorable.
3. Types of Sale Structures
The structure of your sale will also significantly influence your tax obligations. There are several common types of business sales, each with unique tax implications.
Asset Sale
- What It Is: Under this structure, the buyer purchases specific assets of your business, rather than the entire entity.
- Tax Implications: Proceeds from the sale are taxed based on the asset categories discussed earlier. Personal goodwill may also be taxed at the long-term capital gains rate.
- Why Choose This Structure: Buyers often prefer asset sales because they can “step up” the tax basis of the acquired assets, potentially enabling increased depreciation and amortization deductions for future tax savings. Additionally, buyers may avoid inheriting certain liabilities associated with the business entity. The drawback? Although the ability to pick and choose specific assets and liabilities makes asset sales more flexible, it can also make them more complex, requiring renegotiation of contracts, retitling of assets, rewriting of employment agreements, etc.
Stock Sale
- What It Is: This involves selling your ownership stake (shares) in the business to the buyer.
- Tax Implications: Stock sales are typically taxed at the more favorable long-term capital gains rate, as opposed to ordinary income.
Why Choose This Structure: Sellers often prefer stock sales because they simplify the transaction by transferring the entire business entity, including all assets and liabilities, to the buyer. Because the gain on the entire sale is typically taxed as a long-term capital gain, this structure may also reduce the seller’s tax burden.
Employee Stock Ownership Plan (ESOP)
- What It Is: An ESOP allows the business owner to sell shares of their company to a trust that holds shares on behalf of the employees. Over time, employees can gain ownership shares of the company through the trust and enjoy tax-deferred growth. The ESOP trust is considered a tax-exempt entity under IRC Section 501(a), and a qualified retirement plan similar to a 401(k) plan.
- Tax Implications: Depending on the tax structure of the company being sold to the ESOP, owners may defer or potentially eliminate capital gains taxes by rolling proceeds into qualified replacement property. Additionally, the business itself may gain tax advantages, such as tax-deductible contributions to the ESOP, and no income tax on the earnings generated by the company on the portion of the stock owned by the ESOP.
- Why Choose This Structure: This option is ideal for owners looking to reward employees, preserve the company’s legacy and culture, and/or transition partial or full ownership to their employees without selling to an external buyer. The process is often gradual, allowing for smooth ownership transitions and ongoing involvement for the existing owner if they desire. Additionally, shares are sold based on a fair market valuation, ensuring a competitive price for your business
F Reorganization
- What It Is: An F reorganization is a corporate restructuring process often used to facilitate the sale of an S-Corporation. It involves creating a new entity that allows shareholders to reorganize ownership while maintaining certain tax benefits for both buyers and sellers.
- Tax Implications: Sellers can have the transaction taxed as a stock sale, while buyers may treat it as an asset purchase for tax purposes.
- Why Choose This Structure: This flexible option may help mitigate tax burdens and is often used when a business is merging, undergoing private equity investment, or preparing for other strategic transactions. It allows for seamless ownership transitions while preserving tax advantages.
Each type of sale has unique benefits and challenges, and the right approach depends on your business’s structure, the buyer’s preference, and your long-term financial goals. As always, proper planning and the guidance of your advisory team will make the difference in selecting the best option and outcome for you.
4. Terms of Sale
Yet another factor to consider is how the payment terms will influence your tax bill. Different payment terms may significantly affect your tax liability because they determine when you receive the cash. Here’s how timing plays a role:
- Cash at Closing: Receiving the full payment at closing means you’ll owe capital gains tax on the total amount in the same tax year. This may result in a hefty, immediate tax bill depending on your tax bracket.
- Seller’s Note: Payments spread over time allow you to pay taxes on each installment as you receive it, potentially keeping you in a lower tax bracket and reducing your overall liability. However, this carries the risk of the buyer not following through.
- Earn-Out: Used to bridge the gap between the seller’s valuation of the business and the buyer’s willingness to pay up front, an earn-out helps align the interests of both parties, especially in situations where the buyer is uncertain about future profitability or growth. With an earn-out, part of the payment is immediate and taxed that year, while future payments are tied to performance milestones, spreading out tax obligations. This arrangement reduces the immediate financial risk for the buyer while allowing the seller to maximize their payout if the business performs well under its new ownership.
- Equity Rollover: Selling part of the business now incurs immediate taxes on that portion, while deferring taxes on retained equity until you sell it later. While this delays some liability, future taxes could be higher if the business value increases.
Understanding how timing impacts your tax obligations is key to choosing the right payment structure. Likewise, keeping your advisory team apprised of the payment structure isn’t useful only in planning for your tax obligations; your financial and/or estate planning specialists can help you weigh how, when, and where to invest the payment(s) you receive based on your goals.
Preparing for the Sale
While understanding the above considerations is important, I can’t stress enough that effective planning is the key to minimizing taxes in a successful business sale. To ensure a smooth and tax-efficient transition, here are the six most essential parts to incorporate in your tax planning :
- Consult with Experts: Work with financial advisors, tax professionals, and attorneys to understand your tax situation and explore strategies to minimize your risk and liabilities.
- Consider Your Timing: Timing the sale of your business can also help minimize tax liabilities. For instance, strategically planning the sale during a lower-income year or spreading proceeds over multiple years can help reduce tax burdens by keeping you in a favorable tax bracket. Timing the sale early in the year also allows for additional tax planning strategies like offsetting gains with investment losses.
- Involve Personal Planning Early: Integrating your plans to sell your business with your financial and estate planning can further enhance tax efficiency and long-term security. Transferring ownership shares to family members or trusts before a sale can minimize estate and gift taxes, while options like charitable remainder trusts (CRTs) can provide income during your lifetime and reduce estate taxes.
- Be Real With Cash Flow: Likewise, aligning the sale with your expected cash flow needs in your post-ownership life is key to maintaining financial stability while maximizing retained wealth. Structured options, such as installment payments or earnouts, create steady income streams and minimize tax hits from lump sum payouts. Involving advisors who specialize in personal financial planning and estate planning well before you begin the process of selling your business will help ensure a holistic strategy that not only helps you ready the business for its eventual sale but also balances short- and long-term goals while safeguarding your financial future and legacy.
- Understand Your Valuation: Knowing your business’s worth will help you negotiate a fair price and plan for potential taxes on your proceeds. (Learn more about what to expect in and from a business valuation here.)
- Get Organized for Due Diligence: During the due diligence process, the buyer closely examines your business, which can be extensive. Buyers typically focus on:
- Financial Review: Buyers will look at your financial records, including profit and loss statements, balance sheets, tax returns, and cash flow records, to assess the financial health of your business.
- Legal Review: This may involve reviewing contracts, leases, employee agreements, intellectual property, and regulatory compliance to ensure there are no hidden liabilities or disputes that might harm the value of the business.
- Operational Review: Buyers will analyze your day-to-day operations, such as customer relationships, supplier agreements, employee turnover, and the overall efficiency of your business processes.
By organizing and updating all necessary documents in advance, you build trust with potential buyers, reduce delays, and make the transaction smoother. This preparation can also help you justify your asking price.
Without proper planning, however, the due diligence process can expose inconsistencies or unmet obligations, which might lead buyers to request price reductions or walk away entirely. By investing time up front to streamline your documentation and address potential concerns, you increase the likelihood of securing a fair and successful sale.
Maximize Your Proceeds — and Your Future — by Planning Ahead
Selling your business is one of the most important financial decisions you’ll make. As each previous article has sought to show, getting to the point where you not only have the option to sell (or pass down) your business but also can — at a time and arrangement you’re confident is right for you — is a complex and, ideally, lengthy process.
I say ideally because if you take away anything from the Mind Your Business series, I hope it’s the principle shared and repeated by every contributing author throughout these articles.
Successful business transition and succession planning hinges on maximizing your options and outcomes — for your business and your personal and financial future. Achieving success on all three fronts boils down, always, to two things: a well-developed plan and the time to properly implement it.
By starting early, you give yourself the gift of opportunity. Time allows you to influence your business’s operations, nurture future leaders, preserve its culture, and grow its value. It also gives you space to plan for your own wealth, secure your future, and solidify your legacy. In short, the decisions you make today will shape what you can achieve tomorrow.
So, start now. Take the lessons you’ve learned from Mind Your Business and begin preparing for what’s next.
With time on your side, you’ll be ready to create a transition that reflects everything you’ve built and ensures the brightest future for you, your business, and those who follow in your footsteps.
About the Author: With over 25 years of experience, Lisa Newland serves high net-worth individuals and closely held businesses, navigating the intricacies between personal and business planning. From strategic planning to tax, finance and accounting, she brings a depth of experience working with business owners from start-up to wealth transfer.