Tax Planning for the Business Owner Prior to the Sale of the Business

December 13, 2019


Proper tax planning in advance of a transaction can result in substantially higher after-tax proceeds to the seller.
The earlier the planning starts, the less risky the plan is from an IRS audit perspective, and the results are more beneficial, due to the time value of money.Gifts or Sales to Children: Transfer noncontrolling interests in the business to the children or to a Granter Retained Annuity Trust (“GRAT”) for their benefit at fair market value, taking advantage of any permitted discounts for lack of control and marketability. The increase in the value of the business between the transfer (at discounted fair market value) and the sale (with no discounts and possible a strategic premium) inures to the children, estate, or gift tax free. Plan ahead, once the sale is contemplated, discounts start to become smaller.

Charitable Gifts: Donate appreciated stock prior to the transaction. The capital gains tax on the stock is eliminated, and the donor receives a charitable deduction which is particularly useful to offset taxable gains from the sale of the business. Plan ahead, the capital gains tax can only be eliminated if there is still doubt as to the transaction closing. A small discount will be applied to the expected purchase price to account for the uncertainty.

Roll Over To An ESOP:  According to section 1042 of the tax code, a business owner can sell company stock to an employee stock ownership plan (ESOP) and defer federal (and often state) tax on the transaction by rolling the proceeds into qualified replacement property (QRP), such as the stocks or bonds of domestic operating companies. If held through their lifetime, the deferred taxes are extinguished at death, and the children will receive a stepped-up tax basis on these assets.

QSBS: Section 1202 allows small business owners to exclude at least 50% of the gain recognized on the sale or exchange of qualified small business stock (QSBS) that is held for five years or longer. This gain is limited to the greater of $10 million or 10 times their basis in the stock. Section 1045 allows the seller of a business to rollover the taxable gain of QSBS into another QSBS within 60 days of the sale, thus deferring the recognition of the capital gain due until this newly acquired business is sold. This technique can be combined with section 1202 so that some of the proceeds of a qualified sale can be retained as cash, and the remainder can be reinvested in another venture. This technique may be particularly useful for “serial entrepreneurs.”

Allocation of Proceeds: Whether it is an asset sale or a stock sale with a 338 or 336 election, the buyer and seller must agree to the allocation of the purchase price among the net assets for tax reporting purposes. Different assets have different tax attributes and certain allocations benefit either the buyer or the seller. For example, certain intangibles are taxed differently upon sale such as capital gain vs. ordinary income so establishing a beginning basis for each one is crucial for computing the gain or loss on future sale. Specific identification and valuation of customer relationships, supplier relationships, and workforce in place will result in reducing or eliminating amortization recapture. Another example, is that amounts allocated to personal goodwill are taxed to the seller at capital gains rates rather than ordinary income. Plan ahead-Items that are beneficial to the seller should be part of the purchase agreement.
Louisiana Revised Statutes provide an individual income tax deduction for net capital gains from the sale or exchange of equity interests in, or substantially all of the assets of, a non-publicly traded business commercially domiciled in Louisiana. The selling business must transfer at least 90% of the fair market value of the net assets and 70% of the gross assets. The amount of the deduction is based on the holding time in Louisiana.

The common theme? A valuation is required. Consult your tax planner.