Many business owners who want to sell their businesses have not engaged in tax planning prior to the sale. We will briefly discuss both sales to third-parties and sales to insiders – i.e. key employees or family members.
Sales to Third-Parties
There are two basic forms of the transaction – a sale of the stock or a sale of the business assets. Buyers usually prefer to purchase the assets for two reasons. The first is that buyers don’t want to acquire any hidden liabilities of the business that they might become responsible for if they purchased the stock. Second, it is probably advantageous to purchase the assets (particularly if there are significant hard assets such as equipment) because the buyer can then write-off the value of the assets for tax purposes via depreciation resulting in lower taxes going forward as the buyer operates the business.
Sometimes it is necessary to transact a stock sale because there are special assets that can’t be transferred separately. These assets might include franchise agreements, leases, or other contracts. In these cases, a special tax election might be available by which a stock sale can be treated for tax purposes as if it were an asset sale. This type of transaction is complex – only attempt it when you have an advisor who knows how to navigate the intricacies.
Sales to Insiders – Key Employees and Family Members
Surprisingly, insider sales can be more complex from a tax perspective than third-party sales. The problem is with the most common transaction structure – an installment sale of the stock. The key employee/family member will buy the stock with an installment note payable over 5-10 years.
There are various techniques to minimize the overall tax burden on sales to insiders. These techniques involve direct payments from the business to the seller as part of the transaction structure, such as deferred compensation. All these techniques require some period of time to be properly executed which means the owner must engage in planning well before the sale.
A sale of an LLC or partnership interest to an insider requires particular attention to the special rules of partnership taxation. Certain payments to former partners must be treated as ordinary income depending on the mix of assets owned by the partnership. Again, be sure to consult with your tax advisor.
Like all Exit Planning, tax planning for the sale of your business requires advance preparation. If you plan on selling your business in the next five years, you should have already begun the planning process.
This blog is an excerpt from my article featured in the May 2017 issue of Business2Business magazine.