If you’re a business owner and you’ve decided that you want to sell your business, the one topic that usually doesn’t come up in the beginning of the process is taxes. While Uncle Sam is always waiting at the closing finish line with his hand out ready to collect his cut of the sale proceeds, there are numerous strategies that can be used to legally minimize your tax liability. To be clear, you should never attempt to evade taxes illegally, but the US tax code is comprised of thousands of rules and it is the duty of any responsible business owner to use those rules to your benefit to minimize the tax liabilities for your business.
Typically, the tax liability on the sale of a business is usually calculated by taking the total sale proceeds and subtracting retained earnings, accounts payable and any other fees incurred during the sale process for lawyers, M&A advisors, accountants, etc.
One of the most common ways to reduce your tax liability when selling your business is to treat inventory purchases and real estate as separate transactions. For example, if you have $500,000 in current inventory on hand at the time of sale and you sell that inventory to the buyer at cost, it would not be fair for you to pay taxes on $500,000 when you’re essentially getting reimbursed for the at cost value of the inventory. You didn’t make a net profit on the sale of that inventory, but if not spelled out correct in the final purchase agreement contract, that $500,000 could easily inflate the total business sale price, which would increase your capital gains tax liability. An easy method for avoiding this type of unnecessary tax burden is to simply treat the inventory as a completely separate transaction since the sale of inventory would not be taxable. The same could be said for real estate that’s apart of the sale of the business. For example, if a restaurant operates on a parcel of land owned by the seller, it would be fair to assume that in most cases, the seller would expect the buyer to pay for the business and the real estate since you can’t operate the business at this specific location without the property it sits upon. To avoid co-mingling the tax liabilities for the sale of each asset, we always recommend treating the real estate portion of the purchase price as a completely separate transaction with a sperate purchase agreement contract. Separating the real estate portion of the deal into a second separate transaction doesn’t automatically eliminate the tax liability for the sale of the real estate, but there are special tax code rules that specifically govern the proceeds received from the sale of real estate, which means you could potentially roll those funds into the purchase of a new piece of property to avoid or at least delay the tax liability from the sale of the first piece of, property. Meaning, if you take the proceeds from the sale of real estate and use those funds to buy a new piece of real estate, there is a grace period that allows you to reinvest the money within a certain timeframe without having to pay taxes on the first piece of real estate you sold. That’s great if your business includes real estate and inventory, but for those businesses that don’t have those secondary assets included when selling a business, the simplest way to avoid the capital gains tax on the sale of your business is to divert the proceeds from the sale of your business to a holding company. That holding company can then reinvest those into another business or other investment vehicles such as stocks, real estate, options, etc., which essentially keeps the sale proceeds protected behind a tax wall until the cash is withdrawn. For those investors that understand the time value of money, avoiding or even delaying your tax liability through strategic reinvestment is a fantastic way to continuing earning a return on your money before any capital gains taxes become due.
Working with an experienced tax attorney that specializes in mergers and acquisitions is usually worth the cost as the United States tax code loopholes are always changing from year to year. At Smith Holland, our middle market M&A advisors have helped many clients understand the tax implications of the sale upfront to ensure there are no surprises when we get to the closing table. Our in-house counsel has extensive experience with helping clients understand and plan around the potential tax implications when it comes time to sell your business and we are always monitoring the latest loopholes and changes for the U.S. tax code. While nobody enjoys paying taxes, having an experienced M&A deal team on your side can make all the difference when it comes minimizing your tax liability. As described above, structuring the final purchase agreements the wrong way can have a huge impact as illustrated by the inventory example mentioned earlier. The team at Smith Holland has advised on hundreds of purchase agreement contracts over the past decade and we have the industry insight and expertise needed to ensure all considerations are being given to the potential tax liabilities that may arise from how the deal is structured.
Thinking about selling your business? Let’s talk. The experienced M&A advisors at Smith Holland can help you plan and execute the best exit strategy for your business and our in-house legal counsel is always ready to assist with tax implication questions and strategy.
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