Minimizing Taxes for Selling a Business
When selling a business, how the deal is structured is just as important as the selling price. There are three different ways to structure a sales transaction: asset sale, stock sale or stock sale with a Section 338(h)(10) election.
The seller maintains legal ownership of the business entity, while the buyer acquires negotiated assets, including equipment, inventory, customer lists, and so on. Normally, the seller’s cash or long-term debts are not included in an asset sale.
This type of sale is what buyers are more inclined towards due to the fact that they can control their liability exposure and create potential tax savings. The buyer will set up a new entity to acquire the seller’s assets, which means that they are not assuming any of the potential liabilities. The buyer also records the acquired assets at the agreed-upon sales price instead of the seller’s depreciated basis.
For a seller, this option could put them at a disadvantage, especially depending on the business type. If the business is an S Corp, partnership, or LLC any assets that have depreciated are now subject to depreciation recapture if they are sold at a gain. This means that instead of being taxed at a 20% capital gain rate, assets that were sold at a gain are now taxed at the 25% capital gain rate. C Corps could be subject to double taxation because the business is taxed on any gains from the sale, and the shareholders are also taxed on any proceeds they receive once the corporation is liquidated.
Because the buyer is gaining the benefits of reduced income taxes and increased annual cash flow, the seller could anticipate a higher sales price, which is why this structure is highly favorable.
With this sales structure, the buyer purchases business equity, such as shares of stocks or partnership interest. Depreciation recapture can be avoided using this method because the exchange is occurring between the buyer and the business owner instead of the entity itself.
The buyer takes on all liabilities of the selling company, which could include liabilities where exact amounts are not known or recorded on financial statements. All assets acquired by the buyer will also avoid the additional depreciation expense.
Typically, sellers benefit from this structure more because it increases the seller’s net proceeds by reducing their tax obligation.
Stock Sale with Section 338(h)(10) Election
This is a combination of both Asset and Stock sales. The buyer acquires the business entity, but it is treated as an asset sale for legal purposes. The business is deemed to have sold all its assets, liquidated, and distributed the proceeds to the owners under this model.
The above information is of a general nature only and should not be relied upon for specific situations. Click here for additional tax services information.
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