Tax Considerations for Selling a Business

2019 Succession Planning Series Installment #1

Succession planning for your business in 2019 can be a complex endeavor, requiring multiple counsel and advisors on your team helping you set goals, objectives and decision-making processes for a successful transfer. Having a strategy for the future of you and your business offers numerous benefits, such as security and financial stability, protection of profitability, reducing potential litigation and creating a smooth transition in the event of unforeseen circumstances like death or divorce. However, it’s likely that most business owners do not currently have a plan in place, and those that do have likely not discussed their plan with their team of advisors.

One of the most important decisions of your succession plan will be how to transition your business. Depending on your desire to remain involved in management or operations, your financial, charitable, and estate planning goals for the future, and the value you have built in your company, you may decide to sell, transition leadership internally, pass the company to your family, or simply continue the business and allow it to end when you decide to retire. Each of these decisions require thought, planning and communication. Your tax strategy in particular may change as you decide on the future for your business, especially if you are considering a sale to a third-party buyer as opposed to choosing a successor within the business or within your family.

If you are contemplating selling your business as part of your succession plan, the following areas of consideration could be helpful in your next conversation with your advisors regarding tax planning and strategy.

Analysis and Projections

Clients often ask the question, “If I decide to sell my business, how much money will I make from the sale?” If you are looking to sell your business, you may be hopeful that your profit from the sale will be enough to financially justify your exit. However, you may be surprised to learn that sometimes the sale of a business is no more profitable than remaining with the business for an extended period of time. A cash flow analysis, along with financial and income tax projections, will help you understand your net cash after the sale and after paying off any remaining debts associated with the business, including amounts payable to vendors, payroll, real estate debt, existing lines of credit, etc., as well as any taxes associated with the sale, especially if your business has intangible value or appreciated real estate. Your advisors can help you understand your projected profit from a sale after all debts and taxes have been paid and future cash flow compared to your current returns from your business, which may then help you decide whether to proceed with finding a buyer, consider delaying the sale or evaluate other methods of exiting the business.

1031 Exchanges

If you own real estate, a 1031 exchange, or like-kind exchange, may allow you to defer capital gains from a sale by reinvesting your initial real estate investment into another property, which may help you diversify your current income stream or real estate holding portfolio. Traditionally, the properties that qualify for 1031 treatment are rental properties or investment real estate, which must be “swapped” for real property that is of “like kind.” 1031 exchanges are ideal if you decide to reinvest your profit from the sale of your business, allowing you to defer the gain and place cash into another investment of interest. You may also use the deferral to your advantage and plan to sell the subsequent property and recognize the deferred gain at a later date when your income and tax bracket may be lower due to your exit from your business. In order to participate in a 1031 exchange, you must adhere to certain rules regarding the sale and purchase transactions, as well as identify and replace the property within a specified period of time; therefore, it is import to discuss your interest in a 1031 exchange with your advisors prior to a sale.

Opportunity Zone Program

The 2017 Tax Cuts and Jobs Act included a provision for each state to establish specified areas known as qualified opportunity zones (QOZ). Individuals may be able to defer a portion of their gains depending on their holding period of the QOZ property, which may result in up to a 15 percent permanent deferral, as well as a step up in basis for the reinvested property at the time of a subsequent sale if held for at least 10 years. Unlike a 1031 exchange, which requires a rollover of original funds invested to achieve a full tax deferral, only the gain from a sale of an asset is required to be invested in the QOZ. This incentive provides important planning opportunities for investors interested in generating a long-term investment in areas that are designated as QOZ. You may wish to discuss QOZs with your advisors in the event of a sale of your business if you are interested in reinvesting all or a portion of your gain for at least 10 years.

If you have any questions regarding tax implications of succession planning, talk to your trusted advisor or contact the DHG National Tax Desk.