If you started out investing 100K into your business and can now sell it for 10 million, it’s time to strategize about how to keep more of that 9.9 million dollar profit from Uncle Sam. Section 1202 allows small business owners to exclude at least 50% of the gain recognized on the sale or exchange of qualified small business stock (QSBS) held for five years or longer with the gain limited to the greater of $10 million or ten times their basis in the stock.
A federal capital gains tax of 20% would apply to the example above, reducing the net proceeds from the sale to just over $8 million. Add to that state income tax unless you are fortunate enough to conduct business in a state that does not impose that tax.
How is your business is structured? In a pass-through structure (LLC, partnership, S Corporations), individual business owners pay taxes on the company’s profits and any profits generated from the sale of the business. Taxes are not assessed at the company level, and the seller generally won’t incur any additional taxes by characterizing the sale as one of assets rather than the company’s stock.
Your buyer is most likely to prefer a sale of assets as opposed to company stock because tax laws generally allow the buyer to deduct the purchase price. This can make sale negotiations difficult.
C-Corp transactions are more complex. It might be more advantageous to sell the stock of the company rather than its assets to being taxed twice at corporate and shareholder levels. On the other hand, if only the stock is sold, there is no direct transaction with the company and the payment goes directly to the shareholders with no transaction. Shareholders then would pay applicable federal capital gains taxes and state income taxes on the appreciated value of their shares. With C-Corps, stock sales are generally favored due to the large difference in the net return from a sale.
You are likely to be offered a deal that includes cash at closing, a seller’s note, an earn out and an equity rollover. If the sellers are the heirs to the business owner, estate tax can is a significant concern. The road to a successful sale can be treacherous..
Exceptional results require exceptional skill and planning. We can help. You’re welcome to take advantage of a free discovery session, which starts with an intro call HERE