Selling a business can be an exciting prospect — it can fund your next project, your personal passion, or your early retirement. But it’s also financially complicated, and it’s not a venture you should get into without some serious consideration first.
One of the biggest considerations is how much you’ll have to pay in taxes. Generally speaking, the sale of a company is considered capital gains — you founded it, made investments in it, and now it’s worth more than what you invested. That increase in value is what gets taxed, and it can cost you almost 40% of the value of your company if you’re not careful.
We’ll talk about a few of the options you have for reducing the government’s take from your big sale, but your main takeaway should be this: don’t go it alone. Navigating the complicated world of selling a business isn’t something to be taken lightly, and when taxes are involved, it gets even sticker. Mis-filing or claiming deductions you haven’t earned is a good way to get on the IRS’ bad side, and no one wants that. That said, here are a few approaches to look into.
Employee Stock Ownership Plan
An employee stock ownership plan is a great way for owners to roll over the proceeds from the sale of their business on a tax-deferred basis. Essentially, you’re selling your business to your employees rather than an outside party.
The ESOP was created by Congress to help the average member of the workforce accumulate wealth by incentivizing owners to sell to their employees. More specifically, you’re selling your business to a retirement plan like a 401(k), held by a trustee for the benefit of your employees. Since the trust controls the stock, the employees don’t get a say in how the company’s operated, but they do get a payout when they retire.
As for you, the seller, you’re negotiating the sale price like you would in any other circumstance, but you probably won’t walk away with a check for the full purchase price. More likely, you’ll get a promissory note from the ESOP to be paid over the next several years. You might also get some of the money up front (which the ESOP borrows from the bank).
If you sell to an ESOP and the ESOP elects an S Corp. status, the income of your company goes to the ESOP. The ESOP is tax exempt, which means that income now is too. Since they’re not paying taxes, the ESOP is free to pay you the purchase price of the company, as long as you don’t mind getting paid out over several years instead of all at once.
Qualified Small Business Stock Exception
Qualified small business stock (QSBS) is originally issued stock held more than five years in an active C corporation with less than $50 million of assets. There are several other definitions you need to meet in order to be a “qualified” small business in the eyes of the IRS, but the tax windfall can be substantial.
The basic format is this: if you’ve held the stock since its original issuance, you’ve held it for more than five years, and your company is an eligible corporation, the gain from the sale of that stock is partially or entirely excluded from your income. There are other caveats and limits — the amount of gain taken into account in a year is limited by a $10 million cumulative limit and an annual limit of 10 times the basis of QSB stock sold during the year that apply per shareholder and per corporation — but if you qualify, you can essentially sell your portion of your company tax-free.
Convert A C Corp To An S Corp
This strategy won’t apply to everyone, but it could save you a lot of money. One of the provisions of the Affordable Care Act is that if you sell a C Corp., you have to pay a 3.8% surtax on any investment income that brings your adjusted gross income above the threshold amount — $200,000 for individuals and $250,000 for married couples filing jointly.
If you convert to an S Corp., that doesn’t apply. The difference is that you have to stay an active business owner and sell your stock in the business to do so, so you can’t just take your check and walk away, but the savings could be substantial.
Don’t Go It Alone
Does all this seem complicated? This isn’t even the tip of the iceberg. There’s also the matter of deferred payments or installment strategies, price allocations of the various parts of your business — some of them will count towards capital gains and some will be treated as ordinary income — and a hundred other factors to keep in mind.
If we have one lesson to impart from this, it’s that you can use all the help you can get. That’s what we’re here for. We’ll work with your CPA, attorney, and financial planner to achieve the best outcome.
Come sit down with us over a cup of coffee and we’ll talk about your options — how to sell, how to avoid paying half of it back in taxes, and how to get a fair price.