Whether you are winding up, passing the family business down or simply moving on, selling a business has certain tax implications that should be considered before entering a deal. Because the proceeds from selling your business are income, the government is going to want a cut. Read on to find out how much you will owe in taxes when buying or selling a business.
Types
The profits from selling a business are classified as income, thus there are two main ways that it can be taxed: as personal income or capital gains. The type of income that you claim will depend on how your business is structured and how you divest yourself of ownership (which will be discussed later). Though legislation determining the rate and classification of personal income vs. capital gains is constantly developing, in general, personal income is taxed about 10 percent higher than capital gains. So, obviously, the tax advantages of capital gains are greater than that of personal income.
Identification
As mentioned above, determining whether the income from selling your business is personal income or capital gains depends on how your business was set up when it was founded. Businesses in the United States are structured as one of the following: a sole proprietorship, a general partnership, a limited partnership, a corporation, a limited liability corporation, an S-corporation or a C-corporation. There are more factors in deciding structure your business than tax implications upon selling, but for the purpose of this article, we'll only focus on how these different business types affect tax liability.
Effects
As the name implies, a sole proprietorship is wholly-owned by one individual and thus all the tax liabilities and assets fall on you. In a partnership, the liabilities are split between two or more owners, pursuant to a contract, while limited partners have less liability than a general partner. For both a sole proprietorship and a partnership, the seller or sellers must pay capital gains taxes on property sold along with a business and personal income taxes on assets (i.e. inventory, equipment).
For corporations, the sale of stocks has to be figured in. Selling a corporation is advantageous because when stock is transferred, so too are the liabilities. With a corporation, you have the choice of selling either the stock of the company or its assets. If you sell the assets, the shareholders will be liable for personal income taxes from the sale, similar to selling a sole proprietorship or partnership.
Warning
The difference between an S-corporation and a C-corporation lies in how it is taxed. This is particularly important when selling the assets of a company. The government taxes C-corporations twice: the corporation is taxed on profits while the shareholders are also taxed for income from their stocks. In this way, when you sell the assets for a C-corporation, you will be paying twice as much in taxes. Meanwhile, an S-corporation only pays taxes via its shareholders, thus avoiding double taxation.
Considerations
There are many other thing to consider when selling a business that will be unique to your particular situation and jurisdiction. For example, the year you sell your business, how the sale is structured, net gain or loss (if you are the original shareholder) and other unforeseen intricacies. You also have the option to reorganize your business on a tax-deferred basis to avoid selling. Consulting a CPA or a tax professional is highly recommended. You may also want to deal with a broker or another third-party to help facilitate the sale of your business. Preparation and consideration are key when selling your business.
Tags: your business, personal income, capital gains, selling business, sole proprietorship