In order to effectively negotiate and structure the sale of your business, you need to be aware of the tax impact of the transfer and how to minimize your liability. Summarized below are the income tax considerations that apply to the sale of a business. Your own tax adviser should assist you in applying these considerations to your specific situation.

Income Tax Considerations

The rules for computing the income taxes with respect to the sale of your business is extremely complex and it is important to obtain sound tax advice early in the sale process and before you enter into a binding purchase and sale agreement so that you can avail yourself of tax-savings opportunities.

In considering the income tax consequences of the sale of a business, several factors need to be considered:

• Whether your business is conducted individually or through an entity
• If you conduct your business through an entity, how the sale is structured – i.e., whether you sell the entity or the entity sells the assets
• Whether you receive the sales price in a lump-sum or in installments
• If an asset sale, how the sales price is allocated among the different categories of assets - an intricate process (see below).
• Whether any of the consideration received from the sale is paid as compensation for future consulting or employment services

These factors will dictate which of the four separate tax rates will apply to the proceeds of the sale. An overview of the applicable rates is as follows:

1.) Ordinary income rates - The highest marginal tax rate is 35 percent.

2.) Long-term capital gain rate – This rate applies to the gain from the sale of a capital asset which has been held for more than 1 year (if held less than 1 year, it is taxed as a short-term capital gain and the ordinary income rates apply) and is generally 15 percent.

3.) Real Estate Depreciation Recapture Rate – This rate is 25 percent and only applies if you’re selling real estate as part of the sale of your business.

4.) Corporate Income Tax Rate – The corporate income tax rates range from 15 to 39 percent; in addition, the owner then pays individual income taxes upon receipt of the sale proceeds in the form of a corporate distribution – hence, there is “double taxation” when a C corporation sells appreciated assets and then distributes the proceeds to its shareholders.

Note that if instead of the corporation selling its assets, the C corporation shareholder sells her stock of the company held more than a year (i.e., an “entity sale”), there will be only a single tax of 15 percent – the long-term capital gain rate.  If this is not possible, because the buyer insists upon an asset sale, fortunately, your exposure to “double taxation” can sometimes be somewhat minimized by again, structuring the transaction in a certain manner (for example, by having a percentage of the sale proceeds paid to you individually for a covenant not to compete or for consulting). There is also the possibility of converting a C corporation to a Sub-Chapter S corporation prior to the sale (which might eliminate your exposure to a double tax); however, there may be exposure to tax at the highest corporate income tax rate if the corporation held assets, prior to the conversion, with a fair market value greater than their tax basis.

By reviewing the tax consequences in advance and presenting the proposed sale structure in a certain manner, you have a better chance of completing the sale on your terms and conditions.

For more information on the Sale of business, keep visiting Quantum™ Blog.

This entry was posted on Wednesday, February 20th, 2008 at 9:21 pm and is filed under Selling a business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.