Tax On Selling A Business: What Every Seller Should Know

Whether you’ve successfully built a monetized app or developed a thriving e-commerce company, taxes are inevitable. Understanding the intricacies of tax on selling a business is crucial if you want to:

1. Maximize your profits.
2. Be compliant with tax laws.

This article provides a comprehensive overview of the taxes involved with selling a business. We’ll discuss the intricacies of selling a business with capital gains tax and how to structure a deal. Let’s get started and unravel what sellers like you should know about the tax on the sale of your business.

Tax on selling a business: What sellers must know

Selling your business requires you to wander through a labyrinth of taxes and financial considerations. Each is capable of influencing the ultimate gain or loss from the transaction. 

With that said, a comprehensive understanding of the tax on selling a business is crucial. It provides the foundation for a legal and profitable outcome. 

Types of taxes to consider

When delving into the tax on the sale of a business, acknowledging the various forms they come in is crucial. There are three in particular we’ve decided to highlight below:

• Capital Gains: Capital gains tax on a business sale is applied to the profits realized from the sale of assets. It is essential to understand the rate at which a capital gains tax on business sale will be, as it impacts your net profits
• Sales Tax: This tax affects the total transaction value (especially for ecommerce companies). Proper calculation and remittance of sales taxes are vital to avoid legal complications.
• Income Tax: The earnings derived from the sale are subject to income tax. The rate varies based on your tax bracket and influences your overall take-home amount.

A thorough grasp of these taxes allows you to navigate the tax on selling a business adeptly. Keeping them in mind will ensure that you’re rewarded with optimal gains and adhere to laws during your sale.

Determining tax liability

When considering the tax on selling a business, establishing the potential tax liability is equally as important as recognizing the types of taxes involved. Assessing your liability involves understanding the value of the assets and how the proceeds of a sale will be allocated.

Identifying your liability early can help you make informed decisions about sales price and deal structure. An accurate evaluation of the potential tax on the sale of business ensures that you aren’t met with unwelcome surprises after the transaction.

To determine your liability, consider engaging in thorough financial analysis and seeking advice from tax professionals. This insight can aid in optimizing the terms of the deal to minimize tax liability and help maximize your take-home profits from the sale.

A comprehensive understanding of your tax liabilities not only ensures legal compliance but also enables more nuanced, informed negotiations. This can potentially enhance the profitability of your sale.

The impact of tax structure on the sale of business

When negotiating the terms of a business sale, the chosen tax structure plays a pivotal role in determining the final tax on selling a business. Sellers need to comprehend how different structures can significantly affect their tax liability and, consequently, the net proceeds from the sale.

The primary structures to consider are asset sales and stock/share sales. 

When you opt for an asset sale, you’re selling various individual assets and liabilities, not the business entity itself. Assets—ranging from equipment to intellectual property—are classified as either capital assets, depreciable property, real property, or inventory. The classifications of those assets and liabilities can affect your tax gains or losses differently. 

Meanwhile, a stock or share sale implies you’re selling both the assets and liabilities of the company to a buyer. This means the buyer acquires the company as a whole. It’s often preferred by sellers seeking a clean exit and looking to benefit from lower capital gains tax rates by selling the entire entity rather than dissecting it into parts.

Recognizing the tax implications of each structure will help you when in negotiations. You’ll be able to structure a deal that aligns with their financial goals and ensure a smooth, profitable exit from your business.

Is the sale of a business taxed as ordinary income?

When a business is sold, the sale typically comprises various assets, such as inventory, equipment, and intellectual property. The sale of tangible assets like inventory is usually subject to ordinary income tax rates, which are generally higher than capital gains tax rates.

On the other hand, intangible assets and company stocks tend to attract capital gains tax on business sale, which is usually levied at a lower rate. This distinction is crucial as it allows the seller to strategize the sale to benefit from lower tax rates.

Understanding if you’re taxed on ordinary income or as capital gains is pivotal for maximizing the net profits. It’s also important when it comes to maintaining adherence to tax laws following the sale.

How to report the sale of your business on your tax return

In navigating the complex terrain of tax on the sale of your business, you must understand the correct procedures for reporting on your tax return. In 6 steps, here’s how to guarantee you adhere to legal requirements and avoid any tax implications in the future:

1. Identify the Assets Sold: Recognize and list all tangible, intangible, and digital assets included in the sale.
2. Allocate the Sale Price: Distribute the overall sale price to the various assets sold, considering their fair market value.
3. Complete IRS Form 4797: Use this form to report the sale of business property, detailing both gains and losses.
4. Report Capital Gains or Losses: Detail your capital gains or losses on Schedule D of your tax return, considering the allocated amounts to each asset.
5. Fulfill IRS Form 8594: Both buyer and seller must complete this form if the sale includes substantial assets. It illustrates the agreed allocation of the sales price to the assets.
6. Submit the Appropriate Tax Return: Finally, file your tax return, incorporating all the required forms and schedules, by its deadline.

Remember, accurate and lawful reporting of selling business tax is essential. Doing things by the book avoids legal repercussions and optimizes your net profits.

Two essential tips for managing taxes on business sales

Understanding, planning, and strategizing are key components to maximizing profits and minimizing tax liabilities on the sale of your business. This section will delve into various tactics and considerations you can explore to proficiently manage your tax responsibilities and secure a favorable sale.

1. Turn to the pros

Navigating the intricacies of the tax on sale of your business often requires professional advice. A financial advisor can offer insights into the varied tax implications and help structure the deal to minimize financial burdens, including the capital gains tax on a business sale.

Advisory support can also help you conduct a robust business valuation to ensure a fair selling price. Working with a professional can help you establish the economic value of your business and aid in understanding its market position and growth potential. 

At Boopos, we have professionals on hand to help you navigate the complexities of the sales process. We’ve even created a comprehensive tool that can accurately evaluate your business as you get ready to sell. You can check that out here.

2. How to structure your sale

Whether it’s a merger and acquisition or you’re selling your company outright, how the sale is structured will impact the amount of tax on selling a business. A weak structure can lead to higher tax liability, such as higher capital gains tax on your business sale, which will reduce your overall profit.

One key strategy: allocating different sales prices to your various assets. Different assets are taxed at different rates, which can reduce your overall tax liabilities.

If you run either an ecommerce company or an app business, you can break your assets down into the following three categories:

1. Intangible assets

• Brand name/Trademark: The value associated with your company's name and reputation.
• Domain names and websites: The online presence of your company.
• Intellectual property: This could include proprietary software, algorithms, patents, copyrights, etc.
• Customer lists and relationships: The value derived from the existing customer base and relationships.
• Licenses and permits: Any necessary licenses or permits required to operate the business.

2. Tangible assets

• Inventory: For ecommerce, the value of the goods available for sale.
• Equipment and hardware: Computers, servers, and other physical technology used to run your business.
• Office supplies and furniture: Desks, chairs, and other supplies needed for daily operations.
• Real estate: If your company owns any property, it would be considered a tangible asset.

3. Digital assets

• Mobile applications: For app companies, the developed applications and associated user base are crucial assets.
• Website content and design: The created content, including written, visual, and graphic elements, and the overall design and functionality of your websites.
• Databases: Customer data, transaction histories, and other stored information.
• Social media accounts: The company’s profiles and followers on platforms like Instagram, Facebook, Twitter, etc.
  

A meticulously planned and structured sale, coupled with strategic allocation of sale price to various assets, allows you to minimize your tax implications. You’ll also retain a larger portion of your profits.

Read: 9 Methods for an M&A Business Valuation

Get M&A advisory to sell your business

Thinking about selling your business? The right M&A advisory team can help you navigate the sale, avoid tax surprises, and get the best value.

Boopos specializes in guiding business owners through every step of selling, to finding qualified buyers to securing a smooth and profitable deal. Reach out to Boopos today to see how our M&A advisory services can make selling your business easier and rewarding.