Selling the business is part of many small business owners' long-term plans. While many factors may impact a sale, careful planning can help you save on taxes and avoid costly and unexpected tax problems. When a business owner sells their company, the IRS and state authorities will be there to take as much as they legally can. This trade may result in the greatest tax payment a business owner would ever make. It may amount to more than a third of their total net worth.
Top strategies that can help to reduce taxes from the sale of business:
This article discusses the methods we employ to help owners avoid taxes when purchasing their firm. It also helps to fund their future ambitions. Whether they are retirement, estate planning, charitable giving, or even buying their next firm, some of the tactics mentioned herein need cooperation between the buyer and seller. It helps to organize the sale, but others can use it independently. But if you are planning years or are selling your firm right now, several critical areas must be examined. It will safeguard your interests and decrease your overall tax burden.
Qualified small business stock (QSBS):
Selling your shares in a C-corporation (C-Corp) can prevent you from paying federal taxes on capital gains. It comes under Internal Revenue Code Section 1202. The exclusion limits to the greater of $10 million or ten times the purchase price of the shares. Additional advantages include the removal of the Alternative Minimum Tax. It also reduces Net Investment Income Tax on the sale proceeds. Both the company and the investor/owner must need to qualify. Furthermore, the benefits depend on when you buy the stock (maximum benefits apply to stock purchased after September 2010). To qualify:
- The company must be a C-Corp with less than $50 million in gross assets. It must be at the time of receiving the first stock.
- The company also must stay away from performing any trade or activity. It includes areas where the principal asset is the reputation of its personnel. Restaurants, banks, hotels, and farming are also prohibited.
- The owner must have obtained the stock when it was first issued and must not be a company.
- They must also have held the shares for at least five years. If the owner holds the stock for less than five years, the proceeds may be over to another QSBS within 60 days to avoid paying taxes.
Forming a QSBS is less helpful if you expect the firm to generate significant cash flows for the owners. Also, if you are planning to wait to sell the business for an extended period, the predicted capital gains benefit may get canceled in such circumstances. It can happen by the double taxation of profits associated with a C-corp. Furthermore, a QSBS will not work if you intend to sell your company's assets rather than its shares.
Sell your company to its employees:
It is generally better for business owners who plan to sell some of their C Corporation stocks to begin the buyer hunt at home. Set up an Employee Stock Ownership Plan. For example, allow your employees to hold stock in the company. The employee stock ownership plan is a benefit plan allowing employees to buy an interest at a minimal rate. Employers who apply for the program will then be eligible for various tax deductions from the IRS. It is possible to defer taxes on capital gains earned through sales. Direct the cash to a different portfolio, and the IRS will deduct your capital gains.
Do the payment processing in spaced-out installations:
When selling a business or asset, receiving payment in a single lump sum is only sometimes a good idea. Such a large transaction might put you into a higher tax category, raising your tax rates. The rise is from the 10-12% income tax bracket to 20%.
Making this change might increase your long-term capital gains from 0% to 15%, and if you have short-term gains, you could end up paying nearly double the original tax rates. You can avoid this by simply spreading the payments over several tax years. The key here is to present the deal as an installment sale and follow through with a regular payment plan. This should help you with your tax returns because you won't have any large transactions on your IRS forms, and paystubs play a crucial role in keeping track of the payments in the salaries account.
Move to a lower-tax state:
If you have high-income skills, you will have to pay more taxes. But you can save money by adopting these two variations of this strategy:
- The first is a legal ownership transfer using trusts.
- The second option is to relocate physically.
In each case, the goal is to transfer the company to a lower-tax state. You execute the sale and pay fewer taxes after the relocation is final. You may, for example, physically relocate a piece of your company (the sales division, headquarters, or warehouse operations) to a lower-tax state. When you sell the business later, you can deduct a portion of the taxable gain in the lower-tax state. In this scenario, only a part of the sale is taxable in the higher-tax state. You might want to consult with a tax savings consultant to explore all your options. According to this detailed review by GovDocFiling, business formation services like LegalZoom offer tax advisory services that can prove invaluable in reducing your tax liability.
Investments in Opportunity Zones (OZ) have a chance to be the single largest tax incentive available to business owners. These investments also avoid many of the complexity, costs, and time constraints of standard tax solutions. Usually, capital gains on the sale of your firm are recognized (and taxed) at the time of sale. However, consider rolling all (or a portion) of your CG into an Opportunity Zone Fund (OZF) within six months of recognizing the capital gain. In that case, you will receive many tax benefits. The OZF will subsequently invest your capital gains in a qualified Opportunity Zone project, whether real estate or a business. However, to qualify, projects must meet specific criteria. For example, a real estate project must be significantly improved. And enterprises must have most of their staff and operations within an OZ.
Option to Cash Out Early:
Traditional OZ investments need a 10-year lockup of your money. However, restructuring the project after it has stabilized allows you to remove much of your principal tax-free in the first few years. This is like obtaining a home equity line of credit (HELOC) and utilizing the equity in your home as security. For example, in a conventional OZ project, you might use equity to invest in an apartment building. When the project is over, and 80% of the units are leased, it is known as “stabilized” and is eligible for low-cost financing. You can now restructure and receive a tax-free dividend like a HELOC. Significant Opportunity Zone benefits:
- Your original capital gain is recognized at the end of 2026.
- Your original capital gains tax will be reduced by 10% if your investment in the OZ is held for five years by the end of 2026.
Although Opportunity Zones provide a 2% to 3% per year tax credit, be careful of Opportunity Zone Fund costs. Typically, the 1% to 2% per year range can remove the program's tax benefit.
You can use the methods discussed alone or with two or more others. It will help raise your business's value and significantly reduce your tax liability. These ideas offer you a much-needed head start when minimizing capital gains tax on the sale of your firm. However, don't stop there. A competent tax expert can help you streamline your business sale taxes more effectively. At the very least, they have the technical knowledge to follow up on even the most minor concerns you might overlook.