Is this your moment to sell your business and move on to your next project? Will you walk away with enough money for the sale to be worth it? Today, I’ll break down the key aspects of capital gains so you understand how the sale of your business is taxed and what to do to manage your tax liability.
1. Capital gains tax is the government’s cut of the profit you make from the sale of an asset.
When you sell a business, you make a profit if the stock or asset sale price is higher than the amount you invested—this is a form of capital gain.¹
You pay capital gains tax whether you are selling tangible assets like equipment or intangible assets like goodwill or reputation. Make sure you develop a good understanding of the tax consequences of every capital asset transition to avoid nasty surprises.²
2. Your final tax bill hinges on the timing of buying and selling assets.
The capital gains tax rate applies depending on how long you hold an asset before you sell it for profit. The timing is relevant because it directly affects the amount of money you keep versus what you owe in taxes.
There are two types of capital gains.
- Short-term capital gain comes from business assets you’ve held for less than a year, and you get taxed at your ordinary income tax rate.
- Long-term capital gain comes from assets you’ve held for more than a year, and you tend to get taxed at lower rates.
Additionally, you may be subject to the net investment income tax, which imposes an additional 3.8% tax on investment income, including long-term capital gains, based on your modified adjusted gross income.³
3. You can optimize tax benefits by allocating the value of capital gains to assets in different classes.
You can reduce your tax liabilities when you strategically assign the sale price of a business to different individual capital assets.⁴ The two big categories to watch are your tangible and intangible assets.
Tangible assets are typically subject to depreciation recapture.
Depreciation recapture is when you have to pay taxes on the amount of money you saved from deducting the wear and tear (depreciation) of a physical business asset.⁵
If you’ve been using depreciation to save on tangible items such as equipment, inventory, and real estate, the government wants to “recapture” the tax benefits you received from those deductions. It does so by taking a cut of your profit at the time of the asset sale.
Intangible assets tend to be taxed at the capital gains tax rate.
Intangible assets include nonphysical items such as goodwill, patents, and trademarks. The value lies in the premium that buyers are willing to pay for the established reputation, customer relationships, and overall brand value.⁷
Capital gains tax rates are generally lower than ordinary income tax rates, and this can be a real benefit to the seller. A stock sale also has different tax implications because it typically does not involve depreciation recapture.⁷
4. Seller financing and installment sales are strategies that can help you pay less tax in the long run.
One way to manage tax liability when you sell a business is to agree to receive payments over time. There are two primary ways you can do this, and they have subtle but important differences.
Seller financing allows the seller to provide a loan to the buyer for part of the purchase price.
The buyer makes regular payments, including interest, over time. This method spreads out the seller’s income over multiple tax years while also giving the seller additional ongoing profit in the form of interest. Meanwhile, technical ownership of the company transfers immediately without forcing the buyer to seek more outside funding.⁶
An installment sale is a tax strategy where the seller receives payments over several years.
Asset ownership transfers gradually with each installment payment, and the associated capital gains are taxed in the year a payment is made. The point of this approach is to keep the seller’s income in a lower tax bracket each year, reducing the overall tax rate.⁸
5. There are tax policies designed to promote the sales of small businesses.
Take advantage of additional IRS tax breaks, and you can reduce the capital gains tax burden on the sale of your small business.¹ Consider these strategies to make the sale more profitable for you.
- Section 179 Expensing: Deduct the full purchase price of qualifying equipment or software purchased or financed during the tax year up to certain limits.⁸ This can significantly reduce your taxable income in the year of the sale.
- Bonus Depreciation: Immediately deduct a significant percentage of the purchase price of eligible business assets.⁹
- Opportunity Zones: Defer capital gains by investing in qualified opportunity funds that invest in designated low-income areas.¹⁰
- Qualified Business Income (QBI) Deduction: Pass-through entities can potentially deduct up to 20% of their qualified business income, reducing taxable income.⁹
- 1031 Exchanges: Defer capital gains taxes by reinvesting the proceeds from the sale of a business property into another like-kind property.¹¹
Selling a business isn’t like selling anything else.
The best way to make sure your business sale goes through perfectly is to partner with an experienced professional.
If you’re considering selling your business, schedule a discovery call today. You deserve to come out ahead.
Talk soon,
Jeremy A. Johnson, CPA
References
- IRS. Sale of a Business. Available from: https://www.irs.gov/businesses/small-businesses-self-employed/sale-of-a-business
- IRS. Topic No. 409 Capital Gains and Losses. Available from: https://www.irs.gov/taxtopics/tc409
- IRS. Topic No. 559 Net Investment Income Tax. Available from: https://www.irs.gov/taxtopics/tc559
- Wolters Kluwer. Tax Aspects of Selling Your Business. Available from: https://www.wolterskluwer.com/en/expert-insights/tax-aspects-of-selling-your-business
- SmartAsset. Selling a Small Business: Tax Implications. Available from: https://smartasset.com/financial-advisor/selling-a-small-business-tax-implications
- Bessemer Trust. Tax Considerations When Selling a Business. Available from: https://www.bessemertrust.com/insights/tax-considerations-when-selling-a-business
- U.S. Small Business Administration (SBA). 7 Tax Strategies to Consider When Selling a Business. Available from: https://www.sba.gov/blog/7-tax-strategies-consider-when-selling-business
- IRS. Section 179 Deduction. Available from: https://www.irs.gov/publications/p946#en_US_2023_publink1000107452
- IRS. Qualified Business Income Deduction. Available from: https://www.irs.gov/newsroom/qualified-business-income-deduction
- IRS. Opportunity Zones. Available from: https://www.irs.gov/credits-deductions/businesses/opportunity-zones
- IRS. 1031 Like-Kind Exchanges. Available from: https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-tips