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Explore tax strategies to consider when selling a high-value business, from transaction structuring to tax-deferred options. Manage liabilities and plan for a more tax-efficient sale.
How to Manage Taxes When Selling a High-Value Business
Selling a business is more than just a financial transaction—it’s the culmination of years of hard work and investment. But when it comes time to sell, taxes can take a significant bite out of the proceeds if not carefully planned for in advance. The way a deal is structured, when the sale takes place, and which tax strategies are applied can all influence the final tax bill.
With the right approach, business owners can evaluate their options, work with financial professionals, and take steps to manage tax liabilities before and after the sale. From transaction structure to post-sale planning, understanding these factors early can make a meaningful difference in how much of the sale proceeds are retained.
1. Structuring the Sale for Tax Efficiency
The way a business sale is structured can influence the amount and timing of tax obligations.
Stock Sale vs. Asset Sale
Other sale structures can spread out tax obligations or provide tax advantages depending on how the deal is structured:
Installment Sales
Instead of receiving the full sale price upfront, sellers can structure the deal as an installment sale. This spreads the tax liability on the capital gains portion of the sale over multiple years, potentially keeping the seller in a lower tax bracket.
Roll-Up Equity
In private equity situations, a buyer may offer the opportunity to “roll-up” a portion of your sales price into an ownership interest in the acquiring entity. This may allow for deferral of recognition of tax on this portion of the sales proceeds.
Earn-Outs
With an earn-out, part of the sale price is tied to the future performance of the business. This may be taxed as ordinary income or as capital gain, depending on the structure of the deal, while also providing an incentive for continued business success post-sale.
Employee Stock Ownership Plans (ESOPs)
Selling to an ESOP can offer tax advantages, including potential deferral of capital gains under Section 1042. This structure also allows employees to take ownership of the business gradually over time.
2. Pre-Sale Tax Planning
Preparing for a sale in advance allows business owners to review potential tax implications and explore ways to manage liabilities:
3. Business Structure Considerations
The structure of a business can affect tax treatment when it is sold. Reviewing entity type and restructuring options in advance may create tax efficiencies.
Converting a C-Corp to an S-Corp
A C-Corporation is subject to double taxation—once at the corporate level and again when profits are distributed to shareholders. Transitioning to an S-Corporation, when done with careful planning, may allow business owners to potentially avoid this double layer of taxation. However, timing and eligibility requirements must be considered before making the switch.
Qualified Small Business Stock (QSBS) Exclusion
Under Section 1202 of the tax code, qualifying small business stock may be eligible for a partial or full exclusion from capital gains tax if held for at least five years. This can be a valuable tax advantage for eligible business owners, but certain requirements—such as the size of the company and how the stock was acquired—must be met to qualify.
Restructuring an Operating Entity
Business owners sometimes separate different parts of their company into distinct entities for tax or liability reasons. For example, real estate, intellectual property, or equipment might be moved into a separate holding company while operations remain under a different structure. This type of restructuring can have tax benefits depending on the nature of the business and the eventual sale structure.
Holding Real Estate Separate from The Business Entity Being Sold
A seller may maintain ownership of real estate held and used by the business in a separate secondary business entity. Prior to sale, the primary entity to be sold should enter into lease agreements to continue to utilize the real estate owned by the secondary business entity. By doing this, the selling party can have a recurring source of rental/lease income from the acquiring company post-sale.
4. Tax-Advantaged Strategies
Certain tax provisions allow business owners to defer or reduce tax obligations when selling a business.
- Section 1202 Exclusion for QSBS: For eligible stockholders, gains on qualified small business stock may be partially or fully excluded from taxation.
- Tax-Deferred Exchanges: A 1031 exchange may allow real estate components of a business sale to be reinvested without immediate tax consequences.
- Charitable Remainder Trusts (CRTs) or Donor Advised Funds (DAFs): Gifting a portion of the business to a charitable trust may provide tax deductions and provide an ongoing income while avoiding the large tax liability on the sale of the asset. Transferring an ownership interest to a DAF prior to sale can meet the seller’s charitable objective while creating a tax deduction that will reduce the taxable event on the sale of the remaining business interest.
The strategies above are some of the most commonly used tools for managing taxes on a business sale. In certain cases, it may be worth considering a Delaware Statutory Trust.
5. Post-Sale Considerations
Tax planning doesn’t end when the sale is finalized. There are additional factors to consider when managing proceeds from a sale:
- State Tax Residency: Relocating to a lower-tax state before selling could impact overall tax obligations.
- Timing the Sale: Selling before or after the tax year boundary can influence when taxes are due. Making safe harbor estimated tax payments may allow for significant funds to remain in the seller’s account, earning interest prior to the final tax payment in April.
- Tax-Loss Harvesting: Selling other investments at a loss may help offset gains from a business sale.
- Establishing Trusts: Using trusts in tax-advantaged jurisdictions can provide estate planning benefits.
Selling a business involves many financial considerations, and taxes are one of the key parts of the equation. Reviewing different sale structures, exploring tax-deferral options, and planning ahead can help business owners manage their tax obligations effectively.
Because no single approach is right for every business, working with an experienced financial advisor at EP Wealth can help you determine which strategies align best with your short- and long-term financial goals. Contact us today.
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- Information presented is general in nature and should not be viewed as a comprehensive analysis of the topics discussed. It is intended to serve as a tool containing general information that should assist you in the development of subsequent discussions. Content does not involve the rendering of personalized investment advice nor is it intended to supplement professional individualized advice.
- EP Wealth Advisors (“EPWA”) makes no representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented. All expressions of option are subject to change without notice.
- All investment strategies have the potential for profit or loss. Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that any specific investment strategy will be suitable or profitable for a client’s portfolio. The risk of loss can never be eliminated even if working with a professional.
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