Selling a Business: The Tax Impact
6 March 2023: Selling a Business: The Tax Impact
Selling a business entails some costs.
From attorneys and accountants to certain filing fees and brokerage commissions, these costs have to be estimated early in the process so that the seller has some idea what the net proceeds of the sale will be – what they’ll walk away with so they can plan for their post-closing life.
But those costs often pale in comparison to what is generally the biggest hit to the seller – taxes. And it matters little where you are. Governments around the world are hiking taxes to cover the costs of their profligate spending.
Our latest example of this highway robbery comes from the fine folks running the Commonwealth of Massachusetts. But other U.S. states, including California, Connecticut, Hawaii, Illinois, Maryland, New York, Oregon, and Washington – the usual left wing suspects – are all drafting similar proposals.
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If you’d like to learn more, email me at jo*@Wo*******************.com
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And though this rant would seem to take aim at the United States, those of you working in the U.K., Italia, Deutschland and the Land of Oz are not immune from this growing encroachment on the fruits of your labor. Taxes, my learned friends, are heading north.
But it’s incumbent upon advisors to offer our clients ideas that might help them keep a little more of what they’ve worked so hard for and, not unreasonably, believe that they can spend or invest more wisely than any bureaucrat in Washington, London, Berlin, Rome or Canberra.
What’s the Problem?
So, what happened to trigger this little tirade? Well the grand poobahs of the Baked Bean State approved a new 4% tax on residents of the state with annual income of $1 million or more. This, when added to the state’s already confiscatory state income tax rate, brings the top rate to an eye-watering 9% – and it applies to both ordinary income and capital gains.
The people most likely to suffer the most in this draconian attempt to balance the public fisc? Business owners. Our clients.
According to a recent article in Forbes magazine, there were roughly 16,000 Massachusetts income tax returns filed in 2020 with taxable income of $1 million or more, the latest year for which numbers are available. Matthew Erskin, the author of the article, expects that most of those who make over $1 million annually will be able to avoid the tax simply by moving to a less larcenous locale.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
But for those taxpayers who are fortunate enough to realize an income north of $1 million only in a single year – such as the year they sell their business – moving to Florida or Texas – or even just a 90-minute drive north to The Bern’s stomping ground – is not really a legitimate option.
But all is not lost. As with every act of economic lunacy carried out by the political class, there are legions of deep thinkers who consider it their greatest duty to find a way to beat the rascals and this situation is no different. Here are a couple of strategies that should allow our clients to hold on to a little more of the value they worked hard for many years to build.
Spread Out Your Income
Depending on how the tax laws in a particular jurisdiction are structured, there are a couple of ways to employ this strategy.
For example, the way the Massachusetts law appears to be written, that additional 4% tax applies to each tax return reporting $1 million or more in income. As such, married couples could spread the wealth – and keep more of it – by filing separately; each spouse claiming $1 million thereby sheltering $2 million from the extra levy.
Another way owners can keep their hands on more of their earnings is to structure their deal with annual payouts that limit their annual income to a dollar less than $1 million. If our client’s business is sold for $5 million, the deal could be structured so that the buyer makes five $1 million payments for five consecutive years. But make sure your clients calculate what other income they may receive that could trigger the tax. If they have $100,000 in annual rental income, for example, the payments may have to be lowered to stay beneath the bar.
And, of course, you can combine these two methods – spouses filing separately and each receiving up to $1 million every year.
Another way is to transfer the asset(s) into a deferred sales trust or a charitable remainder trust, both of which can be set up so that the sale is complete – insofar as the proceeds are received by the trust – and the proceeds are paid out to the beneficiaries – the owner(s) – over a period of years. In both cases, the owner can establish the timetable for the payouts and the amount the trust pays out each year.
The Nuclear Option
Of course, depending on how the revenuers have treated our clients over the years, some owners will simply pull the trigger on the “nuclear” option out of spite: move.
In the case of Massachusetts, moving to New Hampshire not only averts the new 4% tax but also avoids the state’s standard 5% income tax. New Hampshire has no state income tax. Such a move can, therefore, save a ton of dough. The sale of a business that results in a $3 million gain would generate a tax bill of $230,000 (5% of the first million and 9% on the balance) Massachusetts. That can be a highly motivating calculation!
High earners have been increasingly using this approach to lowering their tax bills for the past 3-4 years, moving from New York to Florida or California to Texas. That trend is expected to continue as high-tax jurisdictions keep trying to grab more and more money from productive tax payers.
Now for the obligatory word of caution…
We’re not tax professionals nor financial planners and the strategies and opinions discussed herein are mine. It is incombent on business brokers to advise clients to seek professional counsel – in this case, a knowledgeable tax planner. If the governments that I’ve had experience with had demonstrated even a modicum of economic intelligence and financial sanity, I might be less fervent in my advocacy for holding on as much of our money has legally possible. But the evidence – spending $477,000 on turning monkeys trans and $550,000 to create zombie Russian cats, are but two small examples – suggests that sending any more of your dough than is absolutely necessary would be more productive if the cash was burned for heat, let alone invested in, for example, a local startup that had the potential of creating jobs. But I digress…..
The Bottom Line
When selling a business, we have to keep in mind that the so-called “millionaire’s tax” is a reality and, rather than cutting wasteful spending, more and more jurisdictions are eyeing it as a means of closing yawning gaps in their budgets. From back-filling underfunded pensions for public employees and programs to encourage people to play golf to bloated and continuously-expanding bureaucracies, governments/bureaucrats at all levels spend money like it’s someone else’s – because it is.
Taxes are arguably the biggest “cost” when selling a business and it’s important that our clients know what they are likely to be facing when the tax man cometh – and have an opportunity to structure the deal (or their life) to keep as much of their money as they legally can.
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
Searching For…
We’ve been approached by a search fund looking for opportunities in the health/wellness and the tech/online sectors. The target business will have EBITDA of $3 million or more and be U.S. based.
If any of you know of something that might fit, please let me know.
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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 500 in the world. He can be reached at jo*@Wo*******************.com