What You Need to Know About Taxes and Fees When Selling a Business

One of the great challenges of managing a business transfer is navigating the complex and ever-changing landscape of transfer taxation, how the government taxes the proceeds of a business sale, and the associated transfer fees, especially during an external sale.

Let’s take a look at these costs in more detail.

What You Need and Don’t Need to Know

You don’t need to be a tax expert, since you can rely on your CPA to do the detailed calculations, but you do need to have a basic understanding of business transfer taxes and fees so you can assess different transfer options and understand how much you will “net” from each. This number is crucial to the success of the business transfer and the future of the business owner. If it is not enough and the sale is consummated, owners may be forced to continue to work in some capacity or reduce their lifestyle in order to have enough money to fund the rest of their lives.

• Taxation on the Sale of a Business: When a business owner thinks about transitioning the ownership of his or her business to an insider or to an external buyer, they don’t often realize just how much of their hard-earned wealth will go toward paying taxes. The tax bite can often be at least 30% and can be as high as 50% or 60% of the sale proceeds!
• Fees on an External Sale: During an external sale transaction, expect to pay transaction fees, including legal, accounting, due diligence, and brokerage fees, which can be substantial.

There are tax planning techniques that can be employed before a transaction to keep taxes to a minimum. There are also tactics and negotiations that can be done during a transaction to minimize taxes and fees. Keep in mind that internal transitions can be done very tax efficiently with lower fees. But in order to take advantage of these strategies, an owner needs sufficient time and planning to weigh all of his or her options. At Business Transition Academy, we recommend owners start their business ownership transition planning at least 3 to 5 years in advance. Most owners will find that taxes play a large part in their decision about transfer options and timing of a transfer. The more informed an owner is about these issues, the better he or she can plan and execute a business transition that maximizes the net proceeds and achieves their goals.

Fundamentals of Transfer Taxes

The type of corporate entity and the way the transfer is structured are the primary drivers for how the transaction will be taxed. “Pass through” entities such as S corporations, limited liability companies (LLCs), and partnerships are taxed differently than C Corporations. Transactions structured as asset sales are taxed differently than stock sales or stock redemptions and there is a way for stock sales to be taxed as asset sales. Sellers typically want to sell stock so they can receive capital gains instead of ordinary income tax treatment and buyers typically want to buy assets so they can depreciate the assets and avoid taking on the seller’s liabilities.

If owners sell their stock, the amount that is taxed is the difference between the selling price and the “tax basis” of the stock. In a C corporation, the basis is what the owners paid for the stock and it does not usually change over time. In pass through entities, stock basis is an ever-changing number that goes up when the company makes money and goes down when owners take distributions.

If an owner sells the business assets of a C Corporation, the transaction will be taxed twice — once at the corporate level and then again on the personal tax return of the owner.

Understanding the fundamentals of how business transfers are taxed will enable owners to evaluate the components of buyers’ offers much more thoroughly and negotiate accordingly. For example, transfers may include multiple types of income streams for the sellers such as cash down payments, note payments, consulting fees, salaries, bonuses, benefits, earnout payments, etc., and these are taxed differently.

What Owners Can Do

Transfer taxes is a very complex area. There are numerous nuances and owners should never attempt to do the calculations themselves. Owners should seek education in this area well before they attempt to sell their businesses either internally or externally. Owners can start by meeting with their CPAs to discuss their current tax situation and find out:

• What type of entity (or entities) they own
• The current tax basis of their stock and business assets
• How much tax they would have to pay under different business transfer scenarios (e.g., internal vs. external) and for different income streams

Understanding business transfer taxes is probably not high on most owners’ lists of things to do, but owners who are contemplating a sale of any kind in the future should make an effort to get properly educated on this topic. It will most likely provide an excellent return on their time and effort in the form of significant tax savings and preservation of their hard-earned wealth.