Tax Consequences of Selling Your Business
With recent legislative changes in Federal tax law, the capital gains tax rate is now 20% (providing you have held your business or asset for 18 months) for appreciated assets. However, federal a capital gains tax isn’t the only issue. There still remains state capital gains taxes in most states (averaging 5.4% nationally) totalling 25.4%.
To make matters worse, some proceeds from the sale of your business and other appreciated assets will be taxed at ordinary income tax rates. For example, if you have been depreciating your assets over time in order to receive a tax deduction, any depreciation claimed up to the date of sale must be "recaptured" as ordinary income when the assets are sold and that portion will be taxed at your marginal income tax rate. The amount you will then pay in tax is best described as "painful".
Let’s look at a common scenario as it relates to a sale of a business. First, we’ll assume the transaction is structured as a sale of your corporation’s assets (preferred strategy for a buyer) compared to a simple stock sale (seller’s common preference). You have built a business through years of hard work, assuming all of the inherent risk of ownership and you now decide it’s time to move on. Your broker has helped you identify a buyer who has offered five million dollars for the assets of your business. You find this acceptable.
Your CPA presents you with an estimated federal tax bill as follows:
Total purchase offer: $5,000,000
Assets |
Allocation |
Basis |
Tax Treatment |
Tax Due |
Equipment, Furniture |
2,000,000 |
0 |
Ordinary Income – 39.6% |
792,000 |
Goodwill |
1,000,000 |
0 |
Capital Gain – 20% |
200,000 |
Non-compete |
500,000 |
0 |
Ordinary income – 39.6% |
198,000 |
Consulting Fee |
500,000 |
0 |
Ordinary income – 39.6% |
198,000 |
Building* |
1,000,000 |
600,000 |
400,000 Capital gain – 20% |
80,000 |
Depreciation recapture building) |
|
|
300,000 Ord. Income – 39.6% |
118,800 |
Total |
$1,586,800 |
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* Originally purchased at 600,000, depreciated over time to 300,000. |
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You find this unacceptable.
What are your options? Take your CPA’s advice and just pay the taxes; give up and donate your business to charity to get a tax deduction; or ask for a higher selling price to offset the taxes, risking the chance that the buyer might back out. If you find these too limiting there may be another option. Contact PBB.
The tax consequences of selling your business can be painful using traditional tax planning methods.
Contact your CPA or Financial Advisor for assistance and then call PBB.
