After selling your business, tax implications are likely the last thing on your mind. But the April 18 tax deadline is less than two weeks away, and if you don’t pay up, the IRS will come knocking.
If this is your first acquisition, you might feel overwhelmed with all the tax paperwork. How do you make sense of capital gains, Schedule Ds, and more? What do you need to know about tax implications before selling your business?
Explore our comprehensive guide to learn what post-acquisition taxes you’ll owe, what IRS forms you need, and how the deal structure affects your tax bill. Read on to know the best way to tackle your taxes after selling your business so you can keep the IRS off your back.
What Business Taxes Do You Pay After Selling Your Business?
Selling your business for profit is rewarding, but it plays a huge role in your post-sale tax implications. The same year you sell, the IRS taxes your sale profit (your capital gain).
Your capital gains tax bill depends on your tax-filing status, taxable income, and how long you held your acquisition assets.
If you hold an asset for over 12 months, for example, you owe long-term capital gains taxes ranging from 0 to 20 percent. Assets held for less than a year are short-term capital gains taxed at ordinary income tax rates of up to 37 percent.
But what other factors determine whether you pay long or short-term capital gains?
How To Navigate Post-Sale Tax Implications
To prepare for the tax implications of selling your business, ask yourself the following questions.
1. What Type of Acquisition Is It?
On Acquire.com, we currently support asset sales only. The IRS taxes each asset individually, so you’ll pay short or long-term capital gains depending on the asset type.
Intangible assets don’t physically exist but contribute value to your startup, like copyrights, trademarks, patents, know-how, goodwill, etcetera. So long as you hold intangible assets for longer than 12 months, you’ll pay long-term capital gains on them at 0, 15, or 20 percent.
Tangible assets are physical assets or property like equipment, inventory, or machinery. No matter how long you hold tangible assets, they’ll always be taxed at ordinary income tax rates.
When considering your tax implications in an asset sale, pay attention to how many tangible and intangible assets you sell. During purchase price allocation (which we’ll cover below), the types of assets you sell determine how much cash you pay the IRS.
Your tax bill also differs if the buyer acquires your stock. Instead of just buying your assets, a stock sale allows the buyer to acquire a controlling or complete interest in your business entity in the form of shares of a corporation or membership units in a limited liability company (LLC).
If those shares include Qualified Small Business Stock (QSBS), you can exclude capital gains tax of up to $10 million or ten times the adjusted tax basis of your QSBS, whichever is greater. Asset sales don’t offer exemptions like QSBS, so if you pursue a stock sale, look for tax breaks like this one.
2. How Is Your Business Structured?
The IRS focuses on five different business types come tax season: LLCs, sole proprietorships, partnerships, S-corporations, and C-corporations. You can see how the IRS taxes each type differently in our ultimate guide to business taxes.
When selling the assets of a C-corporation, you face double taxation. The corporation pays capital gains tax on the sale of its assets, and the shareholders pay tax on the distribution of the net proceeds. Many corporations (or LLCs who elect to be taxed as corporations) pursue stock sales instead to avoid double taxation.
The other four business types, however, pay short or long-term capital gains taxes only once in an asset purchase.
3. What Closing Terms Did You Negotiate?
For many sellers, a fat check at closing sounds heavenly. But once that lump sum lands in your bank account, it can bump you up one or several tax brackets, reaching rates as high as 37 percent. See the chart below for single-filer tax brackets for the 2022 tax season.
Not prepared to pay that much in taxes all at once? Opt for seller financing at closing instead. Seller financing is where you finance the acquisition for the buyer. They put down a cash payment at closing and then repay the remainder in installments over several years.
Though you’ll pay the full tax on your sale eventually, seller financing prevents you from paying one colossal bill in the year you sell. Depending on your financial situation, spreading out the tax bill allows you to put your funds toward new ventures, savings, retirement, and more.
But watch out for buyer default if you finance your transaction – ensure they can keep up with repayments so you don’t lose money on the deal.
If you prefer cash at closing, you can still improve your tax implications after selling your business. Our CEO, Andrew Gazdecki, maneuvered a tax-friendly acquisition when he sold Bizness Apps in 2018.
As part of the closing conditions, Andrew negotiated for the buyer to purchase the $2 million of cash in Bizness Apps’ bank account. Typically, that cash would get distributed to Bizness Apps’ shareholders after the acquisition, hiking up their personal tax return rates. Instead, Andrew added the $2 million to the overall purchase price, which he could allocate into more tax-friendly classes like goodwill and intangible assets during purchase price allocation.
Speaking of purchase price allocation, let’s assess how to negotiate it to your benefit.
4. How Did You Allocate the Purchase Price?
Purchase price allocation is an acquisition accounting process assigning fair value to all acquired assets and liabilities.
During the acquisition process, you and the buyer will negotiate and split the purchase price among seven asset classes defined by the IRS. Usually, the classes that benefit you hurt the buyer and vice versa. Prepare for compromises and hard-pressed negotiations when it’s time to allocate.
After the sale wraps, you both submit IRS Form 8594 to report the purchase price allocation. Filling out this form helps you know how much you owe in short and long-term capital gains taxes and tells the buyer how to adjust the basis for their newly acquired assets.
Below are the seven assets classes and whether you should negotiate for higher or lower allocation in each class (as the seller).
- Class 1: Cash and deposits
- No preference because it doesn’t contribute to taxable gain or deductible loss
- Class 2: Actively traded personal property
- No preference because it doesn’t contribute to taxable gain or deductible loss
- Class 3: Accounts Receivable
- No preference because it doesn’t contribute to taxable gain or deductible loss
- Class 4: Inventory
- Lower because it’s a tangible asset taxed at ordinary income tax rates
- Class 5: Real estate and other fixed assets
- Higher for real estate because it qualifies for long-term capital gains tax rates
- Lower for other fixed (tangible) assets because they’re subject to ordinary income tax rates
- Class 6: Intangible assets except for goodwill
- Higher because it qualifies for long-term capital gains tax rates
- Class 7: Goodwill
- Higher because it qualifies for long-term capital gains tax rates
Curious to see how two companies hash out purchase price allocation? Check out the graph from the Amazon acquisition of Whole Foods below (found in the SEC archives).
According to the document, Amazon bought the grocery retailer for $13.2 billion, with about $9 billion allocated to goodwill and another $2.3 billion allocated to intangible assets (benefiting Whole Foods with long-term capital gains). About $5.6 billion went to tangible assets like equipment and property, benefiting Amazon because those assets depreciate. After subtracting liabilities, you get a total purchase price of $13.2 billion.
5. What Are the Business Tax Laws For Your State?
Federal taxes are just the beginning, I’m afraid. You’ll also owe capital gains at the state level where your business resides. Pay attention to your state’s capital gains requirements.
Here’s a quick rundown:
- Out of 50 states, 41 require capital gains taxes.
- The capital gains tax rates range from 2.9 percent in North Dakota to 13.3 percent in California.
- Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming don’t levy capital gains taxes at the state level.
6. Were You Affected By a Major Disaster?
Natural disasters disrupt our lives every day, but in some cases, the IRS provides leniency when a major catastrophe strikes you or your business’s residence. The agency will extend the deadline to turn in your taxes based on the Federal Emergency Management Agency’s (FEMA) recommendations.
Essentially, if the situation is bad enough to disrupt business operations or everyday lives, FEMA and the IRS step in and take a burden off taxpayers in the affected area.
For example, earlier this year, California suffered freak winter storms, flooding, and mudslides, which affected the lives of residents. Taxpayers and their businesses residing in the disaster area received deadline extensions for individual and business tax returns and tax payment extensions.
Instead of the typical April 18 deadline, these taxpayers will have until October 16 to file returns and pay any taxes (including capital gains taxes) originally due this month.
If a major catastrophe does strike your residence, check out the IRS’s website for more information about potential tax relief in your area.
Which IRS Forms Do You Need?
Every acquisition requires a different set of IRS forms to file post-acquisition taxes. Check out the options below to see which ones you’ll need and how they’ll impact your business sale.
Form 1040
Almost all taxpayers fill out IRS Form 1040, a standard individual income tax return. You can attach several Schedules and other forms to your 1040 to go into further detail about the taxes you owe.
For example, in the screenshot below, you see Line 7 mention capital gain or loss and ask you to attach Schedule D if required. The only time it’s not is if you report your capital gains in another tax form.
Schedule D
In addition to tracking your short and long-term gains and losses, Schedule D also asks you to include details from other forms. You’ll need different ones to cover specific situations related to your acquisition, like reporting like-kind (exchanging business or investment property for property of a like-kind) and real property exchanges.
Some common forms you’ll need to fill out in addition to Schedule D include:
- Form 8949: used to report the sale or exchange of a capital asset not reported on another form or schedule. Also reports the income deferral or exclusion of capital gains.
- Features columns for each asset, the dates the asset was acquired and sold, the sale proceeds, the cost (basis) of the asset, and the gain or loss of profit.
- Form 4684: used to report involuntary conversions (when a person knowingly takes property without permission) of property due to casualty or theft.
- Form 4797: used to report the following:
- The sale or exchange of:
- Real property used in your trade or business;
- Depreciable and amortizable (gradually reducing in cost or value) tangible property used in your trade or business;
- Oil, gas, geothermal, or other mineral property; and
- Section 126 property (any property acquired, improved, or modified using payments outside of gross income).
- The involuntary conversion (other than from casualty or theft) of property used in a trade or business and capital assets held more than 1 year for business or profit.
- The sale or exchange of:
- The disposition of noncapital assets (the act of selling or disposing of easily removed assets) other than inventory or property held primarily for sale to customers in the ordinary course of your trade or business.
- Ordinary loss on the sale, exchange, or worthlessness of small business investment company (section 1242) stock.
- Ordinary loss on the sale, exchange, or worthlessness of small business (section 1244) stock.
- Ordinary gain or loss on securities or commodities held in connection with your trading business, if you previously made a mark-to-market election.
- Form 6781: used to report gains and losses from section 1256 contracts and straddles. Section 1256 is a part of the Internal Revenue Code that covers how the IRS taxes investments like non-equity options, foreign currency contracts, regulated futures contracts, dealer equity options, and dealer securities futures contracts.
- Form 8824: used to report like-kind exchanges. A like-kind exchange occurs when you exchange business or investment property for property of a like kind.
Once you’ve completed all your forms, fill in the blanks on Schedule D and attach them to your 1040. For step-by-step instructions on how to fill out your capital gains tax forms, review the IRS’s guide here.
You Know Your Tax Implications – Now Prepare to Sell
After studying the tax implications of selling your business, you’re one step closer to preparing your business for acquisition. Don’t hesitate to learn more about selling your business on Acquire.com. We’re here to help your acquisition close swiftly and smoothly so you can focus on your next great venture.
Want to know more about how to reduce your taxes after you sell? Check out our top three tips for reducing your tax bill post-acquisition.
Do You Pay Tax on Profit From a Business Sale?
Yes, you pay taxes on the profit from selling your business. After using your tax basis and sale proceeds to calculate your profit, the IRS will tax long-term or short-term capital gains taxes on that amount.
If you hold your assets for over 12 months, you’ll pay long-term capital gains ranging from 0 percent to 20 percent. Shorter than 12 months, you’ll face short-term capital gains, which tax you at ordinary income tax rates up to 37 percent.
What Is Tax Basis When Selling a Business?
According to the IRS, the tax basis of an asset is its original cost to you. It includes the amount you paid in cash, debt obligations, property, or other services. When figuring an asset’s tax basis, also include the sales tax and other expenses you paid for the purchase.
In a stock sale, the tax basis for shares in a company includes the purchase price and additional costs like commissions or transfer fees.
Whether you complete a stock or asset sale, your tax basis helps you calculate your sale profit. The IRS taxes that profit post-acquisition, and to calculate it, you subtract your tax basis from your sale proceeds.
Remember to adjust your tax basis if you’ve increased an asset’s value through improvements or if the asset’s depreciated. Whenever an event occurs during your ownership that increases or decreases your basis, it’s called “adjusted basis.” The IRS will accept an adjusted basis when determining how much you owe in post-acquisition taxes.
At What Age Do You No Longer Have to Pay Capital Gains Tax?
In the past, homeowners over the age of 55 received a tax exemption from capital gains on the sale of their houses. Unfortunately, this rule did not apply to business sales. The Taxpayer Relief Act of 1997 removed the exemption and opened up more tax-saving opportunities for homeowners of all ages.
The only time-related cut on capital gains taxes for a business sale is the 15-year capital gains exemption. If you meet the requirements for both small business relief AND the 15-year exemption rule, you could eliminate your capital gains liability. For more information, check out the FAQs in this blog.
How Much Capital Gains Tax Is Free?
Luckily, capital gains taxes are progressive, just like your personal income tax rates. Even if your profit falls in the 20 percent bracket, you’ll pay 0 percent on the first $41,675, if you’re a single filer. Consult the chart below to see how much you’ll pay in the 0 percent, 15 percent, and 20 percent brackets based on your filing status.
And remember, these tax rates only apply to long-term capital gains you’ve held for over 12 months. Short-term capital gains are taxed at ordinary income tax rates.
The content on this site is not intended to provide legal, financial, or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of a tax advisor before filing your taxes or conducting tax-related operations. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any tax professional.
