- What to consider when determining the term of ownership
- How taxes are calculated on the sale
- The advantages and disadvantages of a deferred sale
What Are The Tax Implications Of Selling Your Business
How Long Have You Owned the Business?
One of the most important variables in determining the tax implications of selling your business is the term of ownership. How long have you owned this business? If your business is an LLC or sole proprietorship and you’ve owned it for more than a year, the proceeds of the sale should be taxed at the long-term capital gains rate. If it’s less than a year, you would instead pay taxes on the sale proceeds as if it were ordinary income.
Because of this, it usually makes sense to own the asset for at least a year or more before you think about selling it. Getting past that arbitrary one year date can have a huge impact on your tax situation as a whole.
Another item that factors in is how you allocate all the assets that you sell. How much of the sale price is tangible assets and how much is goodwill? The tax situation will be affected by how you have depreciated the tangible assets over the course of your ownership of the business. If a large percentage of the sale is tangible assets and you’ve depreciated them, then that can drastically affect the tax situation.
Do You Pay Taxes On the Whole Thing?
If you sell your business for a million dollars, do you pay taxes on that entire million dollars? Luckily, you won’t have to do that. You only pay taxes on the profit that you realized from the sale. How is that calculated? The tax basis that you had in the asset is deducted from the sale price. You are then taxed on the difference between the tax basis and the sale price. That amount is then multiplied by the appropriate tax rate to determine your tax rate. The maximum long-term capital gains tax rate that you would have to pay is 15%.
Another variable that often comes into play is a deferred sale. Many times, business owners will accept payments over multiple years for the business. In those situations, you are not taxed on the entire sale all in that first year. Instead, the money can be taxed as you receive it.
In many cases, the tax implications of selling your business can be improved by engaging in an installment sale. If you structure it correctly, you may be able to get into a lower tax bracket each year of the installment sale, and pay a lower overall tax rate by doing so. The downside to this is that you have to wait on your money. In some cases, business owners would rather get as much cash as they can now and pay a higher amount in taxes so that they can use that cash sooner. For example, if you have another business to invest in now, it might make sense to max out the cash you can obtain this year, even if it costs more in taxes. By the time you’re a few years down the road, you might have made much more in returns on your investment by getting in a new business sooner.
Each situation is different, and it’s important to look at all of these important variables before deciding to sell. Minimizing taxes is important, but it’s not always the most important factor in making your decision about selling. Sometimes, it comes down to how quickly you need cash and what the buyer of the business is willing to do. With the time value of money factored in, it’s better to have as much cash as possible now than it is to have it later. Consult your tax adviser to make sure you understand the implications of your decision.
If you have any questions about selling your business please feel free to contact us.