Starting a business requires hard work and dedication. For many entrepreneurs and business owners, selling a business is the biggest reward because it means they’ve grown a company to the point where somebody else is willing to pay for it.
A common issue for CMP’s business clients who want to sell their companies is how to minimize capital gains taxes. Here's what you need to know.
When you sell a business, you make money. While you might have spent a lot of money to get your business off the ground, you probably took tax deductions and credits to offset some of those costs.
When you sell a business, you’ll need to pay taxes on what you gain. In most cases, the proceeds are taxed at the capital gains tax rate, but some assets may be taxed as ordinary income.
There are several factors that may impact the amount of taxes you’ll pay when you sell your company. Some of these factors include the following:
People over a specified income threshold may also be required to pay a 3.8% Medicare surtax, and we’ll talk about how that can impact your taxes in the next section.
Business sales are taxed based on how much gain the owner recognizes from the sale. Typically, a small business owner will pay for a business valuation to determine the worth of the business and how much they can reasonably expect to receive for it.
A business valuation encompasses the valuation of intangible assets, such as the company's name, reputation, branding, and products, which may be included in the purchase price.
When it’s time to calculate the taxes for the sale of your business, you’ll need to calculate your net gains.
With a stock sale, shareholders may be required to pay capital gains tax on their gains. Corporations may be required to pay an additional corporate tax, as well.
For most of U.S. history, capital gains have been taxed at a more advantageous rate than ordinary income. The Tax Cuts and Jobs Act of 2017 retained the favorable rates for capital gains tax with some changes that affect how the rates are applied. Here's how it breaks down.
Individuals with more than $200,000 in adjusted gross income ($250,000 if married and filing jointly) are also required to pay the Net Investment Income Tax (NIIT) of 3.8%, which is a Medicare surtax.
If you’ve owned a business for less than a year before selling it, the proceeds will be taxed at the ordinary income tax rate.
The goodwill you’ve built for your business is considered an intangible asset for purposes of taxation. Any payment for goodwill must be reported as a long-term capital gain.
Long-term capital gains rates for goodwill are the same as those for any other asset: 0%, 15%, or 20%, depending on your annual income.
There are some important tax considerations that you should keep in mind before selling a business. Here are eight to consider.
The terms of your sale have the potential to impact your taxes, particularly when something other than cash is part of the deal. Here are some of the most common terms and how they’ll affect your taxes.
Many sellers prefer cash at closing because it eliminates uncertainty about future payout. You’ll end up taking the biggest capital gains hit with that option unless you’re selling real estate as part of the deal and can take advantage of a like-kind exchange.
Understanding the tax implications of different sale terms is crucial for optimizing your financial outcome. For more detailed information on the broader tax landscape for small businesses in Utah, including tips on optimizing your tax outcomes, check out our guide: What taxes do small businesses pay Utah.
The sale of a business may be classified in one of two ways:
The type of business entity you sell will impact how the taxes for the sale are calculated. Here's a quick breakdown.
If you have a C corporation that meets the requirements to be classified as an S corporation, you can potentially use an S election to save money on taxes.
When a business is sold, part of the process involves the purchase price allocation, which determines how much of the purchase price will be allocated to tangible and intangible assets.
This allocation has a big impact on taxes. As a rule, it is advantageous to allocate as much of the price to certain types of intangible assets as possible since these are taxed at the more favorable capital gains tax rate.
The taxation and laws regarding how tax is applied to business sales vary depending on where your business is located. State considerations can have a significant impact on how much tax you pay after the sale of your business.
As state laws can be just as complex as federal ones, we recommend hiring a certified tax professional to help you navigate them.
Deciding what value to assign to your business assets is known as business valuation. Some values, such as the cost of business equipment, real estate, and inventory, are relatively straightforward to calculate.
Valuation gets more complex when intangible assets come into the picture. When a business has a stellar reputation and a recognizable brand, it’ll be worth more than a similarly-sized business that lacks those assets.
Selling real estate that your company owns doesn’t need to result in a large capital gains tax bill. One way to defer your taxes is to engage in a tax-deferred exchange, which works only if you reinvest the proceeds of the sale in a like-kind property.
In a like-kind exchange, you won’t need to pay capital gains tax because you won’t realize the gains after buying another property. If you sell the property you bought, you’ll eventually need to pay taxes on your gains, but the 1031 exchange is a way to defer paying taxes until a later date.
Having reviewed some ways to reduce your taxes when you sell a business, here's a recap to drive everything home:
We also recommend working with a tax pro to identify potential tax deductions and credits.
The IRS requires you to report all proceeds from a business sale. There are three forms that you may be required to file.
You should also research your state's requirements for reporting the proceeds of a business sale to be sure you comply with them.
Selling a business has significant tax implications that can be difficult to understand and navigate. While the information we’ve included here is a good starting point, we recommend working with an experienced tax pro to minimize your taxes on the sale of your business. The sale of a business will typically generate additional income, and you'll need to understand how that income is taxed.
Are you preparing to sell a business? CMP can help! Contact us today to schedule a consultation.