Menu

Growing Your Business

Selling Your Business? Three Ways to Cut the Tax Bite

by
Jeff Donohoe, CPA
on
7/14/2016
Selling Your Business? Three Ways to Cut the Tax Bite

When you went into business, you did so with the idea of being successful and turning a profit. You focused on all of the things that you needed to do in order to achieve that goal.

Yet for all of that advance planning that you and so many other small business owners like you do, far too many are remiss when it comes to thinking ahead to the day when it’s time to put the business up for sale — and this can be a big mistake because there are certain steps that make an enormous difference in the taxes you will be obligated to pay.

By educating yourself and taking certain steps, you can relieve yourself of the tax burden you would otherwise face. And under certain circumstances you may even be able to eliminate having to pay taxes at all! For a business selling for $10 million, taking appropriate steps when setting up the business could eliminate nearly $380,000 in taxes owed. 

What You Need to Know

Generally speaking, recent changes in the tax code introduced with the American Taxpayer Relief Act have meant that the total impact of capital gains taxes has jumped by about 8.8 percentage points, to 23.8% from its original total of about 15%.

This is not only due to the increase in the top long-term capital gains rate to 20% from its original 15% rate, but also because of the 3.8% Medicare surtax on investment income for couples that make more than $250,000 ($200,000 for single filers) that came along with the Affordable Care Act. A 23.8% tax burden is a lot to pay – especially when you consider that if you’re a resident of one of the 41 states that impose capital gains taxes, there’s even more to pay.

That’s why it’s so important that you are fully aware of all the steps available to you to offset what the IRS says it is owed.

What You Can Do

Different options exist for different types of business entities. If you are the owner of a C Corporation, then you can take advantage of an ESOP, or employee stock ownership plan. These allow you to take advantage of tax deferrals on the proceeds of the sale of your business by rolling them over and reinvesting them into a specific type of diversified portfolio.

This strategy, referred to as a 1042 rollover for the IRS code that created it as an option, still imposes capital gains on the distributions that you take. But if you don’t distribute them until your death then capital gains taxes are eliminated and the basis for the value gets stepped up.

If your business issues stock that is categorized as qualified small business stock, then you can take advantage of the Qualified Small Business Stock Exception. This provides a 50%, 75% or 100% exclusion on gains (depending upon when the stock was acquired), and provided the stock has been held for over five years. In order to take advantage of this particular strategy, it is often best to have set your business up in that way to begin with, as that makes it much easier to meet the definition and requirements for small business stocks.

This option is not available for those who operate service businesses, though with careful planning a business’ stock can be broken into different categories, allowing some of it to be treated in this way and get the advantage.

For example, if you are in the business of both selling and servicing used computer hardware, you could create separate categories for the business and take advantage of having sold small business stock for the hardware portion when it is time to sell the business. 

Owners of C corporations may have the option of converting their businesses to S corporations in order to save entirely on the Medicare surtax, and this brings us back to the nearly $400 thousand in tax savings referenced earlier. If the owner of an S-corp is active in their business, and sells the stock in their business, the requirement to pay the 3.8% Medicare surtax on the capital gain is eliminated.

This can be a serious sum of money for a company selling for $10 million. If they switch from C corp status to S-corp status before selling the business they may be able to avoid $380,000 in taxes. 

Knowing these types of strategies well in advance of selling your business can yield significant tax savings. If you are anticipating a sale in the not-too-distant future, contact us to set up an appointment and make sure that you have put yourself in the most tax-advantaged position.

share this post
Search for matches...
Jeff Donohoe, CPA

Jeff Donohoe, CPA

Jeffrey D. Donohoe CPA is a CPA based in Cleveland, OH. His firm J. Donohoe & Associates LLC has been providing quality, personalized financial guidance to local individuals and businesses. Their specialty is state and local tax (SALT) services and they work with other CPA firms throughout the country consulting on SALT issues. Donohoe & Associates provide tax preparation and accounting services, as well as audits, financial statement, and financial planning.

J Donohoe & Associates LLC
★ ★ ★ ★ ★
16 reviews

Ohio

Firm Profile

Recommended Professionals

In the face of economic uncertainty, TaxBuzz is the industry's most up-to-date tax information.

Join 60,000 who get our weekly newsletter. No spam.

We know tax and accounting issues are complicated.

Do you have additional questions on this topic for this author?

Related Posts

Latest Posts