How to Reduce Your Tax Liability When Selling Your Small Business

Katie Fleming

Katie Fleming

Co-founder and COO of Owner Actions

A person's hand and pen are shown working on a tax form

Taxes are an important factor in the sale of any small business. Here's why: Proceeds owners receive from the sale are taxed as income, and quite often, large income payouts result in sizable tax bills. Fortunately, there are some strategies that can help you reduce your tax liability when selling your business.

In this article, you’ll learn some of the most common tactics, though they may not all suit your business. Be sure to discuss them with your CPA before proceeding.

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Tactic 1: Avoid a lump sum payment

One of the best ways to save on taxes is to avoid taking the payment for your business in full and, instead, set up a payment plan for your buyer. Typically offered through seller financing, many savvy business owners arrange loans for buyers to borrow a portion of the purchase price and repay it with interest over a defined period of time.

A benefit of this arrangement is that it allows you to spread the income you'd receive from the sale over a period of several years. This move, which can help you decrease your total yearly income, might place you in a lower tax bracket and reduce your overall tax obligation on the sale.

Another benefit is that you can collect interest on the financing you offer your buyer, which can help you come out even further ahead.

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Tactic 2: Focus on capital gains

You could also reduce your tax liability by ensuring that a portion of your business’s sales price is categorized as “capital gains.” Capital gains are profits that owners earn from the sale of a business asset that are taxed at a lower rate than other forms of income.

A valuation specialist or tax expert can help you determine whether each asset being sold can qualify as capital gains or if it needs to be defined as ordinary income. Those that qualify as capital gains must be further categorized as either a short-term or long-term capital gain. While it requires a great deal of work and negotiation with buyers (who often benefit more from ordinary income classifications than capital gains), this practice can result in significant tax savings for sellers.

Would you like to speak with a valuation specialist? Click the button below to connect with our network of specialists.

 

Tactic 3: Consider a stock sale

Another way you might reduce your tax liability is by structuring your exit as a stock sale rather than a sale of assets.

When you opt for a stock sale, you may be able to report a portion of proceeds you earn from the sale as capital gains rather than ordinary income. How this might benefit your tax situation will depend on whether your business is structured as a C-corporation or an S-corporation. Speak with an accountant to determine whether a stock sale will result in a favorable tax outcome for your unique situation.

Stock sales are another instance where the benefit may favor the seller over the buyer. You may need to work with the buyer to come to an agreement that benefits both parties. One option: selling your business for a lower price but structuring the deal so that the after-tax income is more favorable for you.

Important note: Watch out for depreciation recapture

Depreciation recapture occurs when an asset is depreciated below its market value and then is sold for a value greater than its book value. Depreciation recapture is taxed as ordinary income and cannot be spread across multiple years.

In asset sales, the difference between book value and lesser of the sale price or the original purchase price is taxed as ordinary income. But that's not the case when an asset is sold above its original cost. In this case, the difference between the purchase price and the sale price is taxed as capital gains. This may be more favorable for your tax situation. Your accountant will help you to work through this scenario if it’s relevant to you.

 

What’s next?

Thinking about how you'll manage the proceeds of your sale? A wealth advisor can help. This pro can help you to plan your retirement spending, taking into account your expected social security and investment income.

Interested in connecting with a wealth advisor? Check out these firms:

 

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