While taxes are inevitable, the AMOUNT and TIMING of taxes can vary considerably. The advice of a tax professional is quite valuable when planning the sale of your business.
Outlined below are potential strategies and considerations about tax planning when selling your business. For our purposes, we will use the viewpoint of an Asset sale (as opposed to a stock sale). A simple example. Let’s say you acquire an asset for $1,000 and sell it for $1,500 after one year. You’ve recognized a gain of $500. Pretty simple concept, correct? Now the sale of a business usually is not a sale of one asset. Instead, most or all the assets of the business are sold (a few may be retained). How does the sale of business assets differ from the simple example?
When a group of assets is sold, each asset needs to be classified into tax “categories” to determine how they will be taxed. The main categories on a company’s balance sheet are:
- Property held for sale to customers, such as inventory
- Operating assets such as Accounts Receivable and Securities
- Capital Asset (Assets held for over one year) such as land
- Depreciable property used in the business, such as machines
- Real property used in the business, such as buildings
These 5 categories will ultimately be allocated to the following tax categories:
- Capital gains (the lowest rate)
- Depreciation recapture
- Ordinary Income (usually the highest rate)
The objective of the seller is to allocate as much of the purchase price as possible to assets that can be classified to capital gains. Capital gains rates are currently 0%, 15% or 20%. Depreciation recapture rates are 25% while ordinary income rates range from 0% to 37%.
Some assets, such as Receivables have a clear-cut value, based on billing to customers. However, other assets may require judgment, possibly an appraiser to determine value. The allocation of assets can result in significant savings and should be carefully considered when conducting an asset purchase when selling your business.