Selling a business you spent years building can be one of the most rewarding experiences of your professional life. It can also be one of the most financially significant.
Without proper planning, taxes can eat away a large portion of your proceeds, so an exit strategy focusing on tax efficiency is critical.
Whether you plan to sell your business in the next year or decade, there are smart ways to reduce the tax impact and retain more of what you earn.
Understand the type of sale
There are generally two structures for selling a business: asset sales and stock (or equity) sales.
In an asset sale, the buyer purchases business assets like equipment, inventory, and goodwill. This is common for smaller businesses and is often preferred by buyers, who can depreciate some assets.
In a stock sale, the buyer purchases your ownership interest directly. This is more common for corporations and can be more favorable to sellers, especially from a tax perspective. Stock sales are usually taxed at capital gains rates, which are lower than ordinary income rates.
Know your basis and holding period
Your tax basis in the business is what you initially invested, plus additional contributions, minus any losses or withdrawals. This basis will be subtracted from the sale price to determine your gain.
If you’ve held your interest in the business for more than one year, your gain typically qualifies for long-term capital gains tax treatment, which is taxed at 0%, 15%, or 20% depending on your income level. A 3.8% net investment income tax may also apply to high-income earners.
Installment sales
In an installment sale, you spread the sale price over several years. This spreads the tax burden and may allow you to stay in a lower tax bracket. Instead of paying all the taxes in the year of sale, you pay tax on the gain portion of each installment as you receive it.
This strategy requires careful structuring to avoid unintended consequences, like acceleration of gain if the note is sold or if certain contingent payments are involved.
Leverage Qualified Small Business Stock (QSBS)
Section 1202 provides an extraordinary tax-saving opportunity. If your business qualifies as a “qualified small business” and the stock has been held for more than five years, you may be able to exclude up to 100% of the gain on sale, up to $10 million or ten times your basis, whichever is greater.
Requirements include:
- The company must be a domestic C corporation.
- Gross assets must have been under $50 million when the stock was issued.
- The company must be actively engaged in a qualified trade or business.
- The stock must have been acquired directly from the corporation (not from another shareholder).
You must meet all these requirements to benefit from the exclusion.
Use trusts and gifting strategies
Business owners often reduce taxes by transferring shares to family members or certain trusts before a sale. If done far enough in advance, this can shift the tax burden to individuals in lower brackets or remove the appreciation from your taxable estate.
Popular strategies include:
- Grantor Retained Annuity Trusts (GRATs)
- Intentionally Defective Grantor Trusts (IDGTs)
- Charitable Remainder Trusts (CRTs)
For example, contributing part of your business to a CRT before a sale can allow you to defer taxes and receive a partial charitable deduction. The trust then sells the business interest and reinvests the proceeds, providing you with income over time.
Plan for state taxes
Do not overlook the impact of state-level taxes. Some states, like Florida and Texas, do not tax capital gains. Others, like California and New York, do. Where you live at the time of sale can make a significant difference.
If you’re planning to move, consider the timing of your relocation. You may need to establish residency in a new state well before the sale to avoid taxation by your former home state.
Coordinate with your advisory team
Selling a business is complex. The earlier you bring in an experienced tax advisor, the more opportunities you’ll have to reduce your liability. Your team should include:
- A CPA or tax attorney to help with structuring and compliance
- A financial advisor to guide the reinvestment of the proceeds
- An estate planning attorney, if you intend to incorporate gifting strategies
Each professional plays a role in making sure your plan is tax-efficient and legally sound.
What happens after the sale matters
Minimizing taxes does not end with the closing of the deal. What you do with the proceeds can also affect your long-term financial well-being.
Work with your advisor to consider:
- Tax-loss harvesting in your new investment portfolio
- Municipal bonds or other tax-efficient investments
- Opportunities to spread income over multiple years
- Charitable giving strategies, like donor-advised funds or private foundations
Final thoughts
Too many business owners wait until they have a buyer before thinking about taxes. At that point, most of your planning options are limited or gone altogether.
Start early, work with a team, and know your options. The right plan can help you keep significantly more of what you’ve earned.
Disclaimer: There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. All investing involves risk, including loss of principal. No strategy ensures success or protects against loss.