Every small business owner must make an exit at some point. It’s an inevitable fact. In many of these cases, it involves selling the business, whether it’s to a new buyer, employees, the next generation of family, or some combination of these.
What’s the best time to start planning your sale? The first day you’re in business would be ideal (and we’re not kidding). We often tell clients that it takes several years to plan a business exit properly. You may need to restructure, increase business value, put the right successors in place, and more. For a refresher on when and how to sell, read our previous blog post: IS IT TIME TO SELL THE BUSINESS?
Taxes play a significant role when it comes to selling your business. A poorly planned sale could spell disaster for one or both parties in the form of unexpected and debilitating tax liabilities. For this reason, it’s important to discuss any potential business sale with a tax advisor early and often.
Some of the most successful small business sales we’ve seen used one or more of the following tax-friendly strategies:
Installment sale: An installment sale can allow you to spread the gain from your business sale over multiple years, potentially reducing your immediate tax burden while providing access to cash. Generally, you only pay taxes on the amount received each year, which spreads your tax liability and can reduce the overall tax burden significantly. At the same time, it’s an attractive option for buyers who may not have immediate access to full funding.
Employee Stock Ownership Plan (ESOP): Are your employees invested in the future of your business? While this method may not provide immediate access to substantial amounts of cash, it can offer significant tax benefits and a gradual transition out of the business. There are tax deferral opportunities, a potential elimination of capital gains, as well as critical business continuity. Learn more about ESOPs from our previous blog post: MOVING FROM FAMILY-OWNED TO EMPLOYEE-OWNED.
Selling a portion to a third-party buyer: Ownership is not an all-or-nothing scenario. Third parties can be brought in for partial ownership, even if yours is a family- or employee-owned business. For tax and other business reasons, consider how bringing in a partial owner could benefit the future of the business. It could be a party more focused on capital assets or property ownership or someone who is a passive shareholder, willing to help bridge any gaps preventing a complete exit and, once again, opening the door to a more gradual tax schedule.
Transferring ownership to family: Failing to properly plan the transfer of ownership of a family business from one generation to the next is a recipe for failure. Estate and gift taxes may kick in, which could mean a 40% tax on the sale. This high price tag will undoubtedly hinder the next generation’s ability to keep the business open a year after the transfer, much less another generation. Brush up on your family business succession savvy with our previous blog post, 6 FAMILY BUSINESS SUCCESSION TIPS, and then consider how you can best structure a transition or sale to family members. Trusts are a common vehicle many family business owners use to move assets while mitigating taxes, for instance.
Other tools: Every business owner’s situation is unique, meaning the tax-mitigating opportunities are not one-size-fits-all. For instance, tax-deferring capital gains from a business sale by putting it into a Qualified Opportunity Zone Fund (QOZF) could be an excellent option for sellers looking to reinvest. Those wanting to support a charitable cause might consider a Charitable Remainder Trust (CRT) before the sale, which could result in tax and income benefits after the sale.
Keep in mind, also, that a combination of these strategies is often best. As we stated earlier, it’s essential to consult a tax professional who can discuss what fits your needs. Feel free to contact us with questions.
