Without careful planning, taxes can take a significant chunk out of an exiting business owner’s profit. Capital gains taxes, depreciation recapture, and other tax liabilities can reduce the amount of money a business owner walks away with. Fortunately, there are strategies to help a business owner maximize his or her “after-sale” earnings.
Here are seven – (7) common strategies for minimizing the tax consequences to a business owner when they exit their business:
- Understanding the Tax Implications of a Business Sale:
When selling a business, the IRS classifies the income as either “capital gains” – typically taxed at a lower rate – or “ordinary income” – which is taxed at a higher rate.
- Capital Gains Tax: Based on current law, if you have owned your business for more than a year, the profit from selling assets or shares is taxed as “long-term capital gains,” which usually averages between 15–20% for most sellers.
- Ordinary Income Tax: Some portions of the sale, such as recaptured depreciation and consulting agreements, may be taxed at your regular income tax rate, which could be much higher.
- Structuring the Sale to Your Advantage:
A Stock Sale vs. An Asset Sale:
Both “negotiating a stock sale” or “structuring asset allocation strategically” can reduce future tax liabilities.
- Stock Sale (Lower Taxes for the Seller): Selling company stock results in capital gains tax treatment, often benefiting the seller. Buyers, on the other hand, usually prefer asset sales, because the assets are valued at the current market value at the time of the sale, resulting in a higher tax deduction.
- Asset Sale (Higher Taxes for the Seller, but a Higher Tax Write Off for the Buyer): Asset sales allow buyers to depreciate assets, but the seller may face depreciation recapture and higher tax rates.
- Installment Sales (To Spread Out the Tax Burden): Rather than receiving a lump sum, the seller can structure the sale as an “installment sale,” spreading income across multiple years. This keeps the seller in a lower tax bracket and reduces the immediate tax impact.
- Using Tax-Deferred Strategies:
- Qualified Small Business Stock (QSBS) Exemption: If you own shares in a C-corporation for at least five years, you may qualify for Section 1202 of the tax code, which allows exclusion of up to 100% of capital gains on the sale.
- 1031 Exchange for Real Estate: If your business includes real estate, you can defer capital gains taxes by reinvesting in another investment property through a 1031 exchange.
- Reducing Taxable Gains Through Retirement Planning:
- Maximize Retirement Contributions: You can reduce taxable income by contributing proceeds to a Solo 401(k), SEP, IRA, or Defined Benefit Plan, like a Health Savings Account (HSA,) before the sale.
- ESOP (Employee Stock Ownership Plan:) Selling to an ESOP can provide tax deferrals and benefits while keeping the business operational. If structured properly, sellers can defer capital gains taxes indefinitely.
- Minimizing Depreciation Recapture Taxes:
Depreciation recapture applies to assets that have been depreciated for tax purposes and are sold at a gain. Strategies to reduce this tax include:
- Allocating more of the sale price to goodwill and intangible assets.
- Selling certain assets separately to avoid higher ordinary income tax rates.
- Utilizing Trusts and Estate Planning Strategies:
- Grantor Retained Annuity Trust (GRAT) or Charitable Trust: GRATs allow you to pass business assets to heirs tax-efficiently.
- Charitable Remainder Trusts (CRTs): let you donate part of the business, get a tax deduction, and receive income over time.
- Gifting: Gifting allows for limited, annual “tax-free” distributions.
- Working with Tax Professionals Early:
Tax laws are complex, and the right strategy depends on your business structure, timeline, and personal financial goals. Work with a tax advisor, CPA, or exit planning specialist early to identify the best tax-saving opportunities.
In conclusion, selling your business is a major financial event, and proactive tax planning can save you hundreds of thousands — or even millions — of dollars. By structuring the sale wisely, utilizing tax-deferred strategies, and seeking professional guidance, you can keep more of your hard-earned money while ensuring a smooth transition.
About Greater Prairie Business Consulting, Inc.:
Greater Prairie Business Consulting, Inc. is an award-winning, national consulting practice serving entrepreneurs, small to mid-sized privately held and family-owned businesses and middle market companies of any type with revenues between $1 million and $250 million. The firm helps small, mid-sized, and middle market companies maximize their performance and exit.
Greater Prairie Business Consulting, Inc. can be reached by calling 1-800-828-7585 or emailing info@gpbusinesssolutions.com.
About the Author:
James J. Talerico, Jr. is an award-winning author, speaker, and a nationally recognized small to mid-sized (SMB) business expert.
With more than thirty- (30) years of diversified business experience, Jim has a solid track record and an A+ BBB rating helping thousands of business owners across the US and in Canada tackle tough business problems to improve the performance of their organizations.
His client success stories have been highlighted in the Wall St. Journal, Dallas Business Journal, Chicago Daily Herald, and on MSNBC’s Your Business. He was named “Texas Business Consulting CEO of the Year,” by CEO Today Magazine, identified as a “Top 10 Management Consulting Entrepreneur to Watch in 2023” by Entrepreneur Magazine, was listed among the “10 Most Visionary Companies to Watch in 2023” by Inc. Magazine, and has also been ranked among the “Top Small Business Consultants” followed on Twitter.
For more than half a decade, Jim was a regular guest on “The Price of Business,” a nationally syndicated radio program on Bloomberg Talk Radio and has also appeared as a subject matter expert on many FOX Radio interviews. He is a regular contributor to several blog sites and has frequently been quoted in publications like the New York Times, Dallas Morning News, Philadelphia Inquirer, The Entrepreneur’s Review, and on INC.com, in addition to numerous, other industry publications, radio broadcasts, business books, and Internet media.
Jim received a Gold “Stevie Award” for “Thought Leader of the Year,” a Gold “Stevie Award” for “Media Hero of the Year During Covid” and a Bronze “Stevie Award” for “Best Entrepreneur” in the Category of “Business and Professional Services” at the American Business Awards ® in New York City. The competition received more than 3,700 nominations and is the premier accolade for business excellence in the US honoring organizations of all sizes and industries. Jim also received an “Outstanding Leadership Award” at the Money 2.0 Conference for his contributions to the financial services industry.
Jim is the author of “8 Steps to Becoming an ETHICS FOCUSED ORGANIZATION,”™ a small business certification program that utilizes a unique eight – (8) step approach for strengthening ethics in any organization. The certification program won the Better Business Bureau’s “Torch Award for Ethics” for the North – Central Texas Region, the International Better Business Bureau’s “ Torch Award for Ethics,” and a Gold “Stevie Award” for “Ethics in Sales” at the International Sales & Customer Service Stevie Awards ®. Participants who complete this certification program are eligible to receive eight – (8) continuing education units from the University of Texas’ Division of Enterprise Development.
Jim received his Certified Business Exit Consultant (CBEC) ® designation from The International Exit Planning Association (IEPA) to help entrepreneurs, small business owners, family businesses, and middle market companies maximize their business exit, and he received his certification in succession planning from the ASPE.
Jim is also a Certified Management Consultant (CMC) ® and an active member of the Institute of Management Consultants. The Certified Management Consultant ® mark is awarded by the Institute of Management Consultants USA (IMC USA) and represents evidence of the highest standards of consulting, a commitment to continuous development, and an adherence to the ethical canons of the profession. Less than 1% of all consultants in the world are Certified Management Consultants (CMC) ®
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