Business For Sale & Franchise Search Engine  
   
My Account
Search Businesses For Sale
Location:

Category:

to refine your search results use advanced search  
Franchise Opportunities

Sell Your Business, Starting at $20.99 per month
Small Business Resources > Capital Gains Deferral in a Business Sale

Capital Gains Deferral in a Business Sale

The sale of business is a challenging and difficult transaction with several complicated aspects. Whether it's the complete sale of a business or simply the sale of a partial ownership interest in a company, one of the most troubling issues created by this disposition is the manner in which capital gains and other taxes are addressed. There are not many options available to a business owner, and the few that are come accompanied by complex rules and regulations. There are also restrictions that can increase future risk and possibly trigger IRS penalties.

We are always looking for ways for our business sellers to maximize their transaction proceeds while keeping as much possible through the use of intelligent tax planning and deal structure. I asked Dan Carroll from Brook Hollow Financial to explain a unique way to defer capital gains taxes that are the result of a business sale.

Large Tax Bill Due upon Sale

Capital Gains, Depreciation Recapture and even Income taxes may be levied against the proceeds of the sale of the business. Depending on the initial amount invested and how much the business has grown, these taxes can consume much of the sale price. Currently the Federal Capital Gains Tax stands at 15%. Most states have a Capital Gains Tax as well, with the total amount often exceeding 20% of the gain. We believe that these rates will have near term upward pressure caused by the need for the Treasury Department to make up for the $800 billion shortfall that will result from the repeal of the Alternative Minimum Tax. Other taxes, particularly if held in a 'C' Corp., can exceed 60% of the transaction.

Loss of Regular Income

When a business is sold, the owner's cash flow stops as well. Therefore, the amount of money that was being produced needs to be replaced. Without this regular income, former business owners are left with a significant gap in what they receive each month and must alter any plans or budgets accordingly.

What to do with the Proceeds

Another major challenge that a business owner will face is what to do with the proceeds of any sale. There are many ways to put this money to work for you, but this often means accepting significant risk and investing in markets without much experience. Alternatively, sellers might mitigate risk, but only at the cost of getting a very low return. Either way, inadequate returns and potential loss of capital are serious risk factors that must be considered.

Need to Mitigate Future Risk

Among the challenges presented by investing the new capital is that there may be different goals for the individual at this stage of his or her career. If the sale is prompted by a desire to move away from daily management and responsibility, or simply to cash out at a good time in the market, the owner may want to revisit his or her goals. A review of the financial needs and expectations may reveal a requirement for total investment certainty. While these alternatives do exist, most do little to provide a reasonable return and can make planning more difficult with these limited resources. The need and desire to mitigate future risk should play an important role in any decisions about your investment plans.

The Traditional Business Sale - Cash Transaction

The cash transaction option is fairly straightforward. The seller is paid cash from the buyer. After any loans or other debts are paid, the funds are then made available to the seller. At this point, the seller must pay federal and state taxes on the proceeds, and then the remaining balance is left to invest. This drastically reduces the principle and lowers any future returns. The stock market and other liquid investments carry very significant market risk, and the individual could lose some or all of the money. On the other hand, the individual could place the money into a guaranteed investment such as a certificate of deposit, but the returns will drastically lag other possible alternatives. Investing on your own requires some planning and active management of the portfolio, but more importantly, it may provide for unpredictable future income necessary to manage and care for an investor and his or her family.

Another Approach - The Installment Sale

The Installment Sale is a mechanism that has been available since the 1930's. In this type of transaction, the buyer of a business agrees to pay the seller a certain amount of money over a fixed period of time. Under this approach, the IRS has ruled that only the amount of distribution in any given year is subject to any applicable taxes in proportion to the total due. The problem here had been reliance upon the buyer to continue to make the payments promised. Often times the business is run poorly and is no longer producing enough revenue to make the promised payments. There has always been recourse in these transactions, so that if the buyer did not live up to his obligation, the seller could foreclose and reclaim ownership of the business. However, this offered little protection if the business has not been run properly or the value lowers for other reasons, since the original seller would now reclaim a much less valuable business.

An Improved Approach - The Installment Sale with Guaranteed Annuity Payments

There is a way to ensure that these types of transactions could still be utilized while eliminating the possibility of default. The transaction takes place as described above, only there is a second transaction that occurs simultaneously. At the time of closing, the buyer purchases an annuity from an A+ rated Annuity company. Therefore the seller receives a guarantee that regardless of the future strength of the business, the payments will be made as agreed upon, and all of the tax deferral benefits remain intact.

The benefits of this type of transaction are as follows:
  • Seller is able to sell the business without future risk
  • Tax-deferral creates much greater taxable equivalent return
  • Flexible planning allows for specific plans tailored to individual needs
  • Stabilizes future income with certainty for life
  • Much larger total benefit over time - guaranteed
  • Payments can continue to pass on to heirs in the event of death
  • Eliminates need for expensive life insurance
  • Requires no management responsibility
  • There are no direct or on-going fees
  • Expedited closing
A simple way to look at this plan is to compare it to an IRA. With the IRA your investments get to grow on a tax deferred basis for many years and you get the benefit of earning investment returns on the amount not paid in tax. When you draw the funds out of the account, you are then taxed at your then current rate. With the guaranteed annuity installment sale, you may elect to take a portion of the business sale proceeds at close and pay all of the appropriate taxes on that portion.

You then could structure the guaranteed annuity to begin paying you a certain amount starting in 5 years for another 20 years. The investment would be allowed to grow tax deferred for that 5-year period. When you started taking distributions, you would be taxed at the rate you would have been from the original sale transaction. The important thing to remember here is that instead of receiving the entire distribution at closing and paying a huge tax bill up front, you are taking 1/20th of the distribution each year and paying 1/20th of the tax. The remaining portion of the deferred tax stays invested and earns income over the 20-year period. This substantially increases your return on the deferred portion of your sale proceeds.

This mechanism is a great way to secure your proceeds with guaranteed payouts, no ongoing involvement or management responsibility, and beneficial tax treatment. This will ensure the highest possible taxable equivalent return when compared to any fixed-income, guaranteed investment. Remember in a business sale the important number is how much you get to keeep.

About the Author
About the Author
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, representing owners in the sale of privately held businesses. We provide Wall Street style investment banking services to lower mid market companies at a size appropriate fee structure.











Related Resources
Selling a Business
12 Laws of the Business Buying and Selling Jungle - PART I
12 Laws of the Business Buying and Selling Jungle - PART II
3 Reasons To Sell Your Business Now For Maximum Profit
8 Key Steps to Selling Your Business
A Simple Formula For Increasing The Value Of Your Business
Are Business Brokers Licensed?
Auto Franchises
Build Business Value – Before Selling A Business
Business Brokers
Business Lawyer
Businesses for Sale by Owner
C-Corp Asset vs Stock Sale Dilemma
Capital Gains Deferral in a Business Sale
Closing The Deal
Coffee Franchises
Due Diligence - Not As Scary As It Sounds
Financing The Deal
Food Franchises
Franchise Information
Franchise Reviews
Free Small Business Magazines
Great Reasons to Sell Your Business and How to Do It Right
House Cleaning Franchises
How Much is My Business Worth?
How Not to Sell Your Business
How to Sell a Business Online
How to Sell a Small Business
How to Sell Your Business
How To Value A Business
Hurricanes Affect the Value of Florida Businesses
Important Tips When Selling a Business
Preparing a Business for Sale
Protect The Merger Or Sale Value Of Your Business: What You Can Learn From The DaimlerChrysler Deba
Role of Business Brokers in Selling a Business
Run Your Business Like You Have To Sell It
Sell a Business
Sell a Franchise
Sell My Family Business - Deciding to Sell the Family Business
Selling A Business - The Eleventh Hour Contract Change
Selling a Retail Business – How to Sell a Retail Business
Selling a Troubled Business
Selling Your Business - A Tool To Reduce Capital Gains Taxes
Selling Your Business - Prepare for the Buyer Visit
Selling Your Business - Should It Be a Do It Yourself Job?
Selling Your Business - Ten Steps to Increase Selling Price
Selling Your Business - Tips to Selling Your Business
Selling Your Business - What Would Sam Zell Do?
Selling Your Business - Why Use a Business Broker
Selling Your Technology Company - Why Earn Outs Make Sense Today
Should I Use a Business Broker to Sell My Business?
Should I Use a Business Broker to Sell My Business?
Small Business Debt Relief
Tax Tips on a C Corp Asset Sale
The Many Different Deal Structures When Selling a Business
The Pricing Dynamics of Selling a Business
The Ten Commandments of Selling My Business
To Sell a Business or Not Sell a Business A Crossroads Decision
What is a Business Broker?
What is a Covenant Not to Compete?
What is a Letter of Intent?
What is an E-2 Visa?
What is Cash Flow?
What is Due Diligence?
What is EBITDA?
What is FF&E? - Furniture Fixtures and Equipment
What Is My Business Worth? Learn How Small Businesses Are Priced
What is Seller's Discretionary Cash Flow?
When is the Right Time to Sell My Business?


©2017 BusinessMart.com.
Broker Membership | Terms Of Use | Financial Disclaimer | Privacy Policy | Cookie Policy | Resources | Franchise Opportunities | Website Traffic Ranking | Sitemap | Careers | Contact Us