Tax Strategies When Selling a Business
Most business owners who consider exiting are focused on one thing; how can they get the highest offer possible for their company? While this is definitely important, finding a way to protect your capital gains from taxes may be equally or more important. There’s a common saying in business M&A; “It’s not about how much you get for your business, but rather how much you keep in your pocket”. Forming a good tax plan before going on the market will save loads of money come tax season. I’m going to cover some different strategies for cutting or deferring taxes to put more money in your pocket.
Hire Professionals
I need to first mention that I’m not a tax professional and this article is just general information that any good broker will know. It’s highly recommended that you hire either a CPA (certified public accountant), CFP (certified financial planner), tax attorney, or estate attorney. Depending on the size of the business, it might even make sense to hire a full team. If it’s a multi-million-dollar business, the fees paid to a team of professionals will be well worth the amount you’ll save from paying Uncle Sam. Whichever professionals you choose, make sure they’re very familiar with business mergers and acquisitions.
CRT’s and Differed Sales Trusts
A Charitable Remainder Trust (CRT) works by first establishing the trust and then selling the business under the trust so the proceeds are tax free. You pick a charitable cause to contribute to, and then decide how much will be dispersed to you or any other beneficiary of your choosing. It’s a great way to shelter your taxes by spread out profits over a long period of time up to 20 years, limiting your annual tax liability, and providing you with a steady stream of income. It also removes the asset from your estate, effectively protecting you from estate taxes if you die. You also get to deduct the actual charitable contribution you make in the beginning. A CRT is irrevocable which is good because creditors can never touch it, however, the downside is you can’t change the terms once it’s created.
A similar option is to do a Differed Sales Trust which basically works the same way, except you don’t contribute anything to a charitable cause. There are a couple major benefits to using this over a CRT. For one, you have control over how often and how much you want to withdraw, and you can change how disbursement is set up at any time. Another benefit is how the money is used while in the trust. With a CRT, the funds typically just sit there, while a Differed Sales Trust will re-invest the funds into low-risk stocks and bonds. We are partnered with a team of excellent estate lawyers that can provide you with a lot more information on how this works.
Sell Through a C Corp
Using a C Corp as your business entity has huge benefits when selling the business. Depending on the year the C Corp was established, you can protect 50%, 75%, or a full 100% from capital gains tax. There are a few things the business needs in order to qualify. The C Corp needs to be at least 5 years old, established after 1993, have a value under $50M, and be an active business in the US. You also need to make sure you are selling as a stock sale as opposed to an asset sale. If your business is set up as a different entity, you can switch it over to a C Corp, but you’ll need to wait 5 years before selling. Speak with a tax professional to determine if this is a good option for your exit plan. Some industries do not qualify for this benefit.
Using an Installment Sale
Seller financing or an Installment Sale Agreement is a great way limit your tax burden. You can structure how the payments will be made and plan it out in a way that keeps you below a higher tax bracket. Always make sure to protect yourself when offering seller financing. Ask for a large down payment (at least 30%), have the buyer personally guarantee the loan, and have an Acceleration Clause that will require the buyer to pay up in full if they fail to make payments. Also, make sure you are charging an interest fee. The bank collects interest when they loan out money, and you should as well. This will be a bonus benefit to making you even more money in the long run, while also sheltering your capital gains from higher taxes, if done correctly.
Opportunity Zones
The Tax Cuts and Jobs Act passed in 2017 included an incentive that’s perfect for investors selling their business. You can defer taxes by investing in a Qualified Opportunity Fund (QOF) within 180 days after the sale of a business. You would then look for a property to invest in that’s located in a Qualified Opportunity Zone. These zones were created to help improve economically distressed communities, and are located in every city around the US. You will need to spend at least an additional 30% on repairs of the building, but if you hold it in the long term this will have a huge pay off. So long as you hold the property for 10 years, you can then sell it with no taxes on capital gains. There are prorated tax brackets for selling the business after 7 years or 5 years, but the best scenario is hold it all 10. You have until December 31, 2026 to invest in a QOF.
In Conclusion
There are tons of ways you can defer or limit your tax liability. We covered the best strategies that will help you the most, but there are many other ways to form the best tax plan for your personal goals. The best advice I can give you is to hire the right tax professionals who are engaged with business M&A. The costs you pay these professionals will far outweighs the costs you will pay in taxes. We have plenty of great recommendations, so feel free to reach out for our assistance.
