Selling a Business: Capital Gains

08 April 2024: Selling a Business: Capital Gains

The following is adapted from an article that recently came to my attention – and, based on its content and structure, appeared to AI-generated but nonetheless contained nuggets of truth and conjecture that prompted this post’s topic: capital gains taxes when selling a business. (For the full article, visit The Enlightened Mind.)

For business brokers, part of managing the selling client’s expectations is making sure they have some idea as to what they’ll be walking away with when the deal closes. If we’re selling a $4 million business, we’ve go to make sure that our client knows they won’t be walking away with $4MM. Aside from the costs involved – from attorneys, accountants, miscellaneous document prep, data rooms and, most notably, us – there is very likely to be taxes due; capital gains taxes. And they can be significant. In fact, in most Western countries, the majority of which are going broke, such taxes are rising.

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Capital gains refer to the profits that are made when an asset is sold at a price higher than its purchase price. When it comes to selling a business, understanding capital gains can be critical to ensuring that the seller pays the right amount of taxes; that is, enough to comply with the law but not a penny more. This post will briefly discuss what tax issues to consider when deciding whether or not to sell your business, an overview of capital gains and losses resulting from business sales, how to calculate capital gains, and strategies for minimizing capital gains taxes.

When deciding whether or not to sell a business, the capital gains issue is one of many factors to consider. But it’s a BIG one.

Of course, it’s important to understand the potential tax implications of the sale but the seller should also consider the potential benefits of the sale, such as freeing up capital for other investments or allowing the seller to retire. Additionally, there may be personal reasons for selling a business, such as a divorce or partnership breakup or wanting to pursue a different career or lifestyle. It is important to weigh all of these factors before making a decision.

But high on our list of important considerations is that when a business is sold, the proceeds of the sale will generally be subject to capital gains taxes. However, in some cases, the sale may result in a capital loss. In this case, the seller can use the loss to offset any capital gains taxes they may owe from other investments. Additionally, certain assets that are included in the sale may also be subject to capital gains taxes. For example, if the business includes real estate or securities, these may be subject to capital gains taxes when sold.

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We’ve broken our Flagship into six separate modules (or module groups) to give you all the flexibility you need to learn only what you want to learn – and we’ve moved them all over to the new Brokers Academy in The Brokers Roundtable℠ . The Flagship is still available but the modules are now available individually.

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Calculating Capital Gains

In order to accurately calculate capital gains on the sale of a business, it is important to understand the difference between ordinary income and capital gains. Ordinary income refers to income that is earned through wages, salaries, interest, dividends, and other sources. Capital gains, on the other hand, refer to profits that are realized when an asset is sold for more than its purchase price. When calculating capital gains, it is important to take into account any expenses associated with the sale, such as broker’s fees, legal fees, and transfer taxes.

In most cases, when it comes to selling a business, the proceeds may qualify for capital gains treatment. In this case, the profits from the sale will be taxed at a lower rate than ordinary income. It is important to understand the difference between ordinary income and capital gains when calculating taxes on the sale of a business.

In some cases and to some extent, the proceeds of the sale may be taxed as ordinary income. This means that some of the profits from the sale will be taxed at the taxpayer’s marginal tax rate.

The following simple example of a capital gain comes to us from U.S. Bank’s Wealth Management Department. That page has an in-depth explanation of the impact of capital gains taxes when selling a business.

“The sale of a business usually triggers a long-term capital gain for the seller and federal capital gains taxes will apply. As an example, if you started your business 20 years ago with an investment of $100,000 and sell it today for $10 million, your long-term capital gain is $9.9 million (the selling price minus your original cost basis). A federal capital gains tax of 20% would apply, reducing the net proceeds from the sale to just over $8 million.

“State income tax is also a consideration. For example, residents of California could be liable for a tax of 13.3% on the capital gain. Using the example of the sale above with a capital gain of $9.9 million, the net proceeds to the seller after federal and state taxes would be $6.6 million.”

That’s a hefty hit!! – and would seem to explain why some California business owners relocate to Nevada or Texas before selling (or even before starting) their business!

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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.

Minimizing and Strategizing

When it comes to minimizing capital gains taxes on the sale of a business, there are several strategies that can be employed. First, it is important to understand the tax laws in your jurisdiction and to take advantage of any exemptions or deductions that may be available. Additionally, it is important to plan ahead and to consult with a tax professional – at least a CPA or, for more fire power, a tax attorney – to ensure that you are taking full advantage of any available tax breaks.

It’s important to determine the best way to structure the sale. Should it be an “asset” sale or “stock” sale. This decision is especially important of the business owns real estate and/or securities and if those assets will be included in the sale. And finally, it is important to consider the timing of the sale, as the profits may be taxed at a lower rate if the sale occurs in a year in which the taxpayer’s income is lower than usual.

Tax planning strategies can be used to reduce capital gains taxes on the sale of a business. For example, it may be advantageous to structure the sale as an installment sale, in which the proceeds are spread out over several years. This can reduce the amount of capital gains taxes owed in any given year.

A tool we’ve written about in the past is a Deferred Sale Trust, a financial device that will allow the seller defer the taxes for decades while the proceeds, sitting comfortably in a trust, are invested and grow. Another one mentioned by one of the accountants in The Brokers Roundtable is charitable remainder trust. There are similar vehicles that your tax advisors may know about and be qualified to discuss.

Additionally, it may be beneficial to give away a portion of the proceeds to family members or charities, as this can reduce the taxable income. Finally, it may be possible to defer taxes by reinvesting the proceeds in another business or in a tax-deferred retirement account.

In addition to tax planning strategies, it is important to take advantage of any available exemptions or deductions. Depending on the jurisdiction, there may be exemptions available for certain types of capital gains, such as those resulting from the sale of a business. It’s also very likely that certain expenses associated with the sale are deductible such as commissions and legal and accounting fees. Taking advantage of all available exemptions and deductions can help to reduce the amount of capital gains taxes owed.

The Bottom Line

To our knowledge, outside of Argentina, where its new president, Javier Milei, is taking “…a chainsaw to the country’s government“, taxes are going up in most Western countries because they’re all spending FAR more than they’re taking in. In the U.S., the current administration’s record-setting budget blowout – $7.3 trillion – announcement included this statement:

“The fiscal 2025 request seeks to raise the 2017 corporate tax rate from 21% to 28%. Furthermore, Biden is seeking an increase in the corporate minimum tax rate included in his Inflation Reduction Act and a 25% minimum “billionaire” tax rate for people worth more than $100 million. White House officials are adamant that Biden’s proposed reforms would not raise taxes or increase costs for households earning less than $400,000 per year.”

Someone selling that $4 million business that they started 20 years ago and built through all the subsequent ups and down is going to walk away with FAR more than $400,000 when the transfer closes – and, if this spending plan is implemented, will pay one hell of a lot more in capital gains taxes then current tax law would require.

Business owners need to be on defense – and get the right team in place before selling to mitigate the damage caused by wastrel governments.

I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.

If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.

Joe

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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com