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tax implications selling your business

The Tax Implications of Selling Your Business

No stint as a small business owner lasts forever. But if you work hard and you’re fortunate, you’ll at least be able to exit on your own terms — selling your business, and hopefully, getting a considerable return for it.

But like with just about everything, the tax man will want a bite of the final stage of your business’s lifecycle, too.

The tax implications of selling a business can be complex and can vary depending on several factors. These can include the business’s legal structure, sale price, assets involved, even the tax laws of the state (or country) where the business is located.

Everyone’s situation will vary. But here, we’ll cover some of the most important potential tax implications of selling your business.

Exit Planning: Tax Considerations

Here are just a few tax implications you might need to consider when selling your business, including a few strategies that could help lessen your tax burden.

  • Capital Gains Tax: One of the primary tax implications of selling a business is the capital gains tax. When you sell a business for more than its original cost (the basis), the profit made from the sale is considered a capital gain. This gain is subject to taxation at the applicable capital gains tax rate — possibly short-term (if you held the business for a year or less), but most likely long-term (a year or more). Federal long-term capital gains rates are either 0%, 15% or 20%, depending on your taxable income. Most states (though not all) also charge capital gains taxes, though the amount varies by state.
  • Ordinary Income Tax: The sale of certain assets, such as inventory or accounts receivable, may be taxed as ordinary income rather than capital gains. This is because they are considered part of the regular income generated by the business.
  • Qualified Small Business Stock (QSBS): In the U.S., under certain conditions, individuals may be eligible for an exclusion of up to 100% of the gain from the sale of QSBS. With this exemption, shareholders (be it the owner or investors) can deduct up to $10 million in taxes or 10 times the adjusted cost basis, whichever is greater. The ordinary capital gains rate applies to all earnings above that amount.
  • Depreciation Recapture: If the business owned depreciable assets (e.g., machinery, equipment, real estate) that were previously written off for tax purposes, the depreciation claimed may be subject to “recapture.” Effectively, a portion of the gain on the sale of these assets could be taxed at ordinary income tax rates.
  • Entity Structure: The way your business is structured (e.g., sole proprietorship, partnership, LLC, corporation) will impact the taxation of the sale. For example, selling assets in a corporation may result in double taxation (once at the corporate level and again at the individual level). There are ways of avoiding this, such as making a Section 338(h)(10) election. From a taxation standpoint, this treats the transaction as if it were an asset sale.
  • Installment Sales: Depending on the terms of the sale, you may be able to report the gain on an installment basis, spreading the tax liability over multiple years.
  • State and Local Taxes: Remember: Selling a business doesn’t just have federal tax implications. Always explore your state and local tax laws, as they might differ from federal tax laws and could affect the overall tax liability on the sale.

Selling Your Business? Don’t Wing It.

No matter your reason for exiting your business, it’s in your best interest to do so in the most tax-efficient manner possible. Doing so can save you literally thousands of dollars — maximizing your reward for selling the business you helped build.

McManamon & Co. helps small and midsize businesses with a number of services, including advising on mergers and acquisitions. We can help you assess your company’s value, negotiate favorable deal terms, and, of course, address tax and financial reporting implications.

Reach out and find out what we can do for you and your business! Just call 440.892.8900 or contact us online.

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