Summary
- Selling your business for a profit triggers capital gains, which can range from 0% to 28%. Most business owners will pay 15% or less.
- If you want to reduce or eliminate taxes, you may want to take a closer look at an ESOP, a 1031 exchange, an installment plan, a charitable trust, and more.
- For all your questions about selling your business, transferring wealth, and tax planning, Unbiased can match you with an advisor suited to your needs.
How is the sale of a business taxed?
Selling your business for a huge profit is usually great news. However, with a tax bill due, you’ll also want to know how much of it you get to keep.
Your taxes will depend on the form of the sale, which will be considered either a stock or an asset sale. Buyers like asset sales for the tax advantages. Business owners with a C-Corp may prefer to sell stock rather than assets to avoid double taxation.
Is selling a business considered capital gains?
Yes, selling a business triggers capital gains because the proceeds of the sale go beyond the cost basis.
The IRS considers the value of each asset in the business, not just the business itself. The gain or loss is figured separately for each. These are classified as:
- Capital assets
- Depreciable property used in the business
- Real property used in the business
- Property held for sale to the customer, such as inventory or stock in trade
Short-term gains (gains on businesses owned less than a year) are subject to ordinary income tax at the graduated tax rates.
Long-term capital gains are taxed at rates between 0% and 28%, though most are taxed at no more than 15%.
For example, your capital gains rate is 0% if your income and tax filing status are:
- $48,350 for single and married filing separately
- $96,700 for married filing jointly and qualifying surviving spouse
- $64,750 for head of household.
Your capital gains rate is 15% if your income and tax filing status are:
- Between $48,350 and $533,400 for single filers
- Between $48,350 and $300,000 for married filing separately
- Between $96,700 and $600,050 for married filing jointly and qualifying surviving spouse
- Between $64,750 and $566,700 for head of household.
Your capital gains rate is 20% if your taxable income exceeds these amounts
There are a few exceptions where you’ll see higher capital gains tax rates, including selling section 1202 qualified small business stock at 28%, selling collectibles at 28%, and unrecaptured section 1250 gain from real estate at 25%.
After you’ve paid your federal taxes, you’ll also likely pay taxes at the state level.
How to avoid capital gains tax on a business sale
There are strategies to consider to avoid capital gains on the sale of your business. Some of these include:
- Qualified small business stock (QSBS): You may be able to exclude up to 100% of capital gains if you’re a qualified small business and domestic C-corp with assets under $50 million. Investors and small business owners must hold the stock for at least five years.
- 1031 exchange: A 1031 exchange is where capital gains are deferred when the proceeds from the sale of a business are reinvested into a similar business. Typically applied in real estate when one property is sold, and another similar property is bought to replace it.
- Qualified opportunity zone: Capital gains can be deferred when you reinvest the proceeds into an area considered a qualified opportunity zone (QOZ). There are typically economically distressed communities. Your benefits increase every year you hold the QOZ investment. After 10 years, you can increase the basis to full market value for a full step-up with no capital gains taxes.
- Employee stock exchange program (ESOP): C-Corp owners who sell their business to their employees via an ESOP can defer capital gains completely when they reinvest the proceeds into qualified replacement property (QRP). QRP includes domestic stocks and bonds. The exchange must be completed within 15 months.
- Installment sale: Gradually selling your business over many years can spread out the capital gains taxes you pay when you sell your business for a profit.
- Charitable remainder trust (CRT): You can make a tax-deductible gift of your business interests (or shares) to a charitable remainder trust. The donation is split - some goes to the charity while some comes back to you as an annuity. Once the annuity term ends, the rest of the money goes to charity.
How to minimize taxes when selling a business
Minimizing taxes comes from employing strategies like these:
- Build a team of experts: There’s no substitute for expert advice. A CPA, attorney, financial advisor, and others can help you navigate the complexity and expense of selling a business.
- Plan years in advance: With a few years (or more), you have more options for reducing your tax liability with different gifting and sale strategies. It’s also more likely you’ll fetch a higher valuation than a business that tries to sell quickly.
- Negotiate asset class value: When selling your business, the buyer and seller can negotiate what value is assigned to the seven different classes of business assets. Negotiating more capital gain in certain asset classes can reduce the tax you’ll need to pay.
- Take advantage of rollovers and exclusions: There are some rollovers the IRS incentivizes by offering zero or low capital gains, such as ESOPs, charitable trusts, and qualified small business stock.
- Transferring ownership in tax-efficient ways: When you transfer ownership to an heir now and sell at a later date, you’re able to freeze the value of the business at the value it holds today.
- Reducing income tax: When your income tax is lower, you’ll pay a lower capital gains rate. You can reduce income with charitable trusts, investing in opportunity zones, setting up distributions to heirs through trusts, and more.
Tax strategies to consider when selling a business
There are some key strategies to avoid capital gains when selling a business. These primarily involve gifting the business years before selling it to freeze the value of the business. Appreciation is shifted away from you to avoid or minimize capital gains.
Gift stock to your heirs
You can transfer up to $19,000 per year ($38,000 per couple) of company stock to each child. You can gradually gift your business to your children by using the gift exclusion amount each year.
Installment sale to an IDGT
An IDGT (Intentionally Defective Grantor Trust) is a type of trust for your children where assets grow tax-free. If you transfer ownership of your business to this trust now and then later sell to a third party for more money, you can keep the appreciation of the business in the trust.
Private annuities
You can exchange your business for annuity payments for your children running the business now. Just be sure you have a kid with a good head on her (or his) shoulders.
Grantor retained annuity trust (GRAT)
You can transfer shares to a trust with annuity payments. Furniture growth can pass to heirs without the need to pay capital gains.
Charitable lead annuity trust (CLAT)
You can support your charity of choice through a trust, a charitable lead annuity trust (CLAT). With this trust, you’re able to make donations and then transfer stock to the team.
Family limited partnership (FLP)
Setting up a family limited partnership (FLP) offers the ability to gift non-voting shares to heirs while retaining voting control. FLPs are pass-through entities that may lower the overall tax burden.
Bottom line
Professional financial advice is invaluable when you’re selling your business. Some strategic moves could impact your bottom line.
Unbiased can connect you to a financial advisor who can answer any questions you have about selling your business and keeping more of the profits.