Updated: Mar 10
The price of the business is just one point an experienced business broker negotiates. Experienced brokers negotiate every detail of the transaction to maximize the total money/value a seller receives.
Selling your business produces income and owners have to pay taxes on at least part of their gains from the sale. How these capital gains are taxed depends largely on the structure of the business and how the assets are allocated. Critical considerations to keep in mind are:
Whether the business is being sold as a set of assets or as an entity
The type/classification of assets being sold
The allocation of the assets being sold
How the business will be sold and the resulting tax implications
The IRS generally views a business as a collection of assets — including real property, equipment, inventory and goodwill. The gain or loss on the sale of different categories of business assets are taxed differently. When they are sold, the assets must be classified for IRS purposes as capital assets, depreciable property used in the business, real property used in the business, or property held for sale to customers (such as inventory or stock in trade). Under the Internal Revenue Code, sellers and buyers must assign a specific value to each asset or groups of similar assets, and report a gain or a loss from the sale of each asset to the IRS. The sale of capital assets results in a capital gain or loss; the sale of real property or depreciable property used in the business and held longer than one year results in a gain or loss from a Section 1231 transaction; and the sale of inventory results in ordinary income or loss.
Selling Options Upfront
Accepting the full purchase price at closing presents the lowest risk strategy for selling your business but it may not maximize the money you put in your pocket.
Taking the full purchase price at closing presents the greatest tax exposure because it forces you to accept all sale proceeds in a single year. This will likely push you into higher tax brackets and ultimately less money after the government takes their share.
Depending on your sale strategy, it may make sense to receive all proceeds upfront. But if you insist on receiving the entire sale price now, you have to be willing to accept the fact that you will likely pay a higher tax rate on a portion of the sale.
One of the most common ways to reduce the tax liability of a business sale is to receive payment over time. By deferring the receipt of proceeds over multiple years, you can control your tax rate by managing the portion of the sale price that falls into higher tax brackets.
Seller financing a portion of the business is a common tax strategy used by sellers to avoid higher taxes. Seller financing payments are typically promissory notes from the buyer to make payments to the seller at a negotiated interest rate. Offering Seller financing can also help the Seller ask more for the purchase of the business. Seller financing can help some buyers close the deal when other funds are not available. The caveat is that you will need collateral or other measures to protect your interests should the buyer fail to make scheduled payments.
Negotiating price allocation
For IRS purposes, the buyer and seller must agree on the allocation of price among the assets that are being transferred in the sale. Some assets are treated as capital gains and taxed at a lower rate, while others are treated as ordinary income and taxed at a higher rate.
As a seller, your goal is to include as many assets as possible under the capital asset classification. But reaching an agreement with the buyer won't be easy because capital assets are depreciable and tax deductions for capital assets are amortized over a much longer period of time.
Although specific IRS rules govern the allocation of assets, it's in your best interest to negotiate an agreement that maximizes the portion of the purchase price allocated to capital assets.
Many of the strategies for managing the tax burden of a business sale also provide other benefits for sellers. For example as mentioned earlier, by offering seller financing, you may be able to receive a higher sale price as well as the tax benefits of a deferred payment strategy.
The tax consequences of selling your business also depend on the structure of the business. What type of business entity do you have? Because sole proprietorship's, partnerships and limited liability companies (LLCs) are considered “pass-through” entities, owners of these companies enjoy a degree of flexibility in negotiating an asset sale.
C corporations can sell both stocks and assets, but, unlike pass-through entities, a C corporation is taxed twice when its assets are sold. The company pays the corporate tax rate on any gains realized from the sale of the assets, and the company’s individual shareholders pay capital gains taxes when they receive distributions from the liquidation of the corporation. But when a C corporation sells its stock, the seller pays only capital gains taxes on the profit from the sale.
Meanwhile, in purchasing a company’s stock, the buyer is acquiring the company as an entity, including any of the business’s existing liabilities. If (instead of purchasing the stock) the buyer acquires the company’s assets, the buyer receives a new tax basis in the assets, and higher depreciation and amortization deductions in the future. So, buyers are more likely to want to acquire the assets of a company rather than the stock, while the seller may prefer to sell the company as an entity. Because a stock sale usually results in a lower overall total tax bill than an asset sale, the seller may wish to consider adjusting the purchase price in order to persuade the buyer to accept a stock transaction rather than an asset sale.
S corporations are taxed in a manner more similar to that of partnerships than of C corporations, and thereby avoid this double taxation. The income or losses of an S corporation flow through to the shareholders, who report those numbers on their personal income tax returns and pay taxes on that income at their individual income tax rates. Therefore, no second taxation occurs when an S corporation sells its assets.
Schedule a consultation meeting!
Scheduling a consultation to discuss your business and your selling goals is easier than you might think. We can arrange to meet at a time and place convenient to you. You are always welcome at my FNBC office. You will have the comfort of knowing your employees will not be made aware of your potential interest in selling your business.
If you’re thinking about selling, feel free to call me at any time to discuss your options and get your questions answered. Cordially,
FNBC Kansas City Business Broker