Tax Implications of Selling a Business: What You Need to Know

When selling your business, taxes can significantly impact the sale and the proceeds you receive. Whether it’s part of your retirement plan or a strategic move to start something new, the financial rewards can be significant. However, the amount you actually take home from the sale depends heavily on taxes. Understanding the tax implications is key to making informed decisions and maximizing your profits.

What factors determine how taxes will apply? Your business structure, the type of sale, and the terms of the agreement all play a role in how taxes are assessed.

Here are the key takeaways about the tax implications of selling your business:

Taxes can affect both the sale process and the proceeds you keep.
The structure of your business and the type of sale will influence how you’re taxed.
Understanding tax considerations, including federal and state taxes, is critical.

To navigate these complexities and make the most of your sale, it’s important to break down the factors that influence how taxes will apply. Let’s explore these considerations in detail.

Tax Considerations When Selling Your Business

Without proper planning, tax implications can be significant. Here are six questions to consider when preparing for the sale of your business:

1. How Are You Taxed When You Sell a Business?

The sale of a business typically triggers long-term capital gains tax. If you’ve owned your business for many years, this tax could reduce the net proceeds you receive. For example, if you sell your business for $10 million and originally invested $100,000, your capital gain is $9.9 million. A federal capital gains tax of 20% would apply, reducing your sale proceeds by $1.98 million, leaving you with about $8 million.

In addition to federal taxes, state income tax may apply. States like California, for instance, can impose a state tax of up to 13.3%. With this added tax, your net proceeds could be significantly lower.

2. What is the Structure of Your Business?

The structure of your business (LLC, S Corporation, C Corporation, or Partnership) can affect how your sale is taxed.

Pass-through entities like LLCs, S Corporations, and Partnerships don’t pay taxes at the company level; the owners report profits and losses on their personal tax returns.
C Corporations face more complicated tax rules, as they are taxed at both the corporate and shareholder levels. The type of structure determines whether an asset sale or a stock sale is better for minimizing taxes.

3. Will It Be an Asset Sale or a Stock Sale?

In an asset sale, the company’s assets are sold. In a stock sale, the buyer purchases the stock or ownership shares of the business.

For pass-through entities (LLCs, partnerships, S Corporations), the tax implications of an asset sale are usually straightforward.
For C Corporations, a stock sale is often preferred to avoid double taxation—taxes at both the corporate level and again when the proceeds are distributed to shareholders. If assets are sold instead of stock, the company faces a substantial tax burden, and shareholders are taxed again on the distribution.

4. What Do the Buyers Want?

Buyers often prefer to buy assets rather than stock because it allows them to deduct the purchase price for tax purposes. For example, if the buyer purchases assets for $20 million, they can depreciate equipment over time and amortize goodwill, reducing their taxable profits.

If your business is a C Corporation, however, a stock sale might be more beneficial to you as the seller, because it avoids the double taxation scenario described earlier.

5. What Are the Terms of the Sale?

The terms of the sale can affect how taxes are paid:

Cash at closing is the simplest and preferred method for many sellers, as the capital gains tax is due in the year of the transaction.
Seller’s note: If the buyer can’t pay the full amount upfront, they might offer an IOU, paid off over time.
Earn out: The buyer may pay part of the price upfront and the rest over time based on the business meeting performance milestones.
Equity rollover: If the buyer purchases part of the company, the seller may retain equity to benefit from future growth.

If you’re not receiving all cash upfront, the structure of the payment can affect your tax planning. For example, selling to a buyer in a state with no income tax can reduce your future tax burden if part of the sale payment is deferred.

6. What Other Taxes Might Apply?

In addition to federal and state income taxes, estate taxes might apply to the proceeds from the sale if you pass away after selling the business. Make sure your estate plan is up-to-date to address this.

12 states and the District of Columbia have their own estate taxes, which can be significant. These taxes are separate from federal estate taxes and may apply depending on where you live at the time of your death.

Seek Professional Guidance

Selling your business is complex, and the tax implications are just one part of the puzzle. Consulting with a team of professionals—including financial advisors, tax experts, and business and estate attorneys—can help you navigate the tax considerations and other aspects of the sale. Proper planning can ensure a smooth and financially successful transition.

At Archipelago Wealth Management, we understand the intricacies of business exits and offer tailored solutions to meet your specific needs. Our team of professionals are dedicated to guiding you through every step of the process, from financial assessments to negotiation strategies, with personalized attention and care.

Reach out to us today to learn how we can assist you in achieving a successful business exit and embarking on the next chapter of your entrepreneurial journey with confidence and peace of mind.

Then, read on for our 10-Point Checklist for Exiting Your Business.