Selling Your Business? Here's How to Help Minimize Taxes

By Trent Derrick, CMT®

Selling a business can be both rewarding and challenging, especially when it comes to managing the tax implications. As a business owner, your goal is to get the best value from the sale and at the same time keep your tax bill as low as possible. This not only helps increase your profits but also gives you more financial freedom to enjoy your retirement.

The good news is there are several strategies you can use to accomplish this. In this article, we explore how to sell your business in a way that helps reduce your taxes and optimizes your earnings. We cover important topics like understanding capital gains tax, valuing your assets, negotiating effectively, and other key strategies to help you make a tax-efficient sale of your business and a seamless financial transition.

Plan for and Reduce Capital Gains 

One of the primary considerations when selling a business is the impact of capital gains tax. Capital gains tax is a tax on the profits earned from the sale of an asset, such as a business or investments. The amount of tax owed is determined by several factors, especially the duration of ownership. When you sell after owning an investment (or business) for more than a year, you will qualify for the lower, long-term capital gains tax rate, as opposed to the typically higher ordinary income tax rate. Generally, short-term capital gains are taxed at the marginal tax bracket, while long-term capital gains are taxed at a lower rate of 0%, 15%, or 20% depending on income level. This sale must be taken into consideration with other types of income you may have throughout the year, so you can plan ahead for your tax bill and pay the least amount possible.  

Valuing Assets

Another key area to determining your tax liability is the assets your business owns. Items like real estate, equipment or machinery, raw materials and supplies, and intellectual property all need to be taken into consideration before you finalize any sale. Each party has a different interest in valuing these assets, so it’s important to understand that in negotiations. During the process, the buyer and seller naturally want a favorable basis, respectively. The buyer wants a higher allocation of the valuation listed to assets to increase a higher basis and have the ability to depreciate those assets quickly, while the seller wants a lower allocation toward assets in order to reduce capital gains and their overall tax burden. It is also important to understand the order for allocating valuation of assets, which prioritizes easier-to-value assets (such as cash and deposits held in checking or savings accounts), while pushing down harder-to-value items (like goodwill). 

Additional Strategies

In addition to the points mentioned above, there are other strategies that may be a fit depending on your situation and your business. While these aren’t one-size-fits-all solutions, they are ideas you can discuss with your financial advisor and professional team.

Section 1202

Section 1202 of the tax code provides an opportunity for small business owners to reduce their capital gains tax liability when selling their business. This section allows for tax exemptions on certain types of small business stock, which can result in significant tax savings. To take advantage of Section 1202, business owners must meet specific criteria, such as having held the stock for at least five years and meeting certain size requirements. 

Section 1045 or 1045 Rollovers

Under Section 1045 of the Internal Revenue Code, if you sell qualified small business stock and meet specific requirements, you can roll over the gain into another qualified small business investment, deferring the recognition of capital gains tax. 

Section 1400Z-2

Similarly, Section 1400Z-2 allows for the deferral of capital gains tax on the sale of Qualified Opportunity Zone Property if the proceeds are reinvested in another Qualified Opportunity Zone Property.

Negotiate an Installment Sale

Another strategy is to structure the deal as an installment sale, agreeing to receive payments for the business over time rather than in a lump sum. This can help spread out your tax liability over a longer period of time, reducing the amount of capital gains tax you owe in any given year. 

Deduct Business Expenses

It is also important to deduct all eligible business expenses prior to the sale of your business. This helps reduce the amount of your total taxable capital gains, and thus lowers your overall tax bill. If you’re uncertain what to deduct, work with a tax professional to take advantage of all relevant expenses and confirm compliance with all applicable tax laws and regulations.

Plan for Estate Taxes Expenses

If you’re looking to pass on the sale proceeds to your heirs, it’s a good idea to explore some estate planning strategies to help keep estate taxes as low as possible. You might think about gifting some business shares before you sell or setting up trusts to manage the proceeds.

Timing Is Key 

When it comes to selling your business, timing is everything. Starting to plan well in advance—ideally years before the sale—allows you to implement strategies that could take time to execute, such as restructuring your business or qualifying for certain tax benefits. Plus, tax laws and economic conditions constantly change, directly affecting how much you’ll pay when you sell your business. That’s why working with your advisors is crucial to help pinpoint the optimal timing to sell your business.

Use Tax-Advantaged Retirement Plans 

Another effective way to manage some of your sale proceeds is to contribute to a tax-advantaged retirement plan. By moving these funds to a 401(k) or an individual retirement account (IRA), you can defer the tax liability and potentially maximize your accounts. This way, you’re setting aside more funds for retirement and getting a tax break for the year of contribution.

Partner With a Financial Professional to Optimize Your Strategy

Although there are many strategies to help reduce your tax bill, it’s wise to take the time to talk to an experienced financial advisor before making any moves to help avoid any costly mistakes. Your business and personal finances are too important and specific for a one-size-fits-all solution.

If you’re looking for personalized advice that fits your business and financial goals, our team at Legacy Wealth Management is here to assist. Just reach out and email me at trent@legacywm.com.

About Trent

Trent Derrick is a financial advisor and Chief Market Technician at Legacy Wealth Management. He is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning strategies, cash flow management, and retirement planning. Trent obtained his bachelor’s degree from the College of Charleston, studied economics at the University of South Carolina, Columbia, and is a Chartered Market Technician® (CMT®) professional. Outside of the office, he serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. To learn more about Trent, connect with him on LinkedIn.

The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.