Every business owner has a silent partner: Uncle Sam. And he plays a big role in the sale of a business. There are two tax considerations for the business seller regardless of what kind of entity is being sold:
• Will the income from the sale be taxed as ordinary income or capital gains?
Currently, ordinary income rates top out at 39.6%. Also for 2013, there is an Unearned Income Medicare Contribution Tax of 3.8% that applies to net investment income for taxpayers whose modified adjusted gross income exceeds $200,000 (for single filers) and $250,000 (for married filing jointly). Thus taxpayers in the highest tax bracket will face a combined 43.4% marginal tax rate on their investment income. The capital gains rate that most people and transactions fall into is 15%. That’s a big difference in rates. Naturally most sellers want to have the income reported as capital gains to obtain more favorable tax treatment. But how the income is treated (and thus taxed) depends on what kind of entity the company is, and how the sale is structured.
• When will the income from the sale be taxed?
Generally speaking, income is taxable when it’s earned. And when the income is earned depends on how the seller and buyer structure the payments. There are two types of sales when it comes to selling a business: a sale of corporate stock or a sale of the company’s assets. Each type of business entity (sole proprietorship, partnership, C corporation, LLC, and S corporation) has its own issues when it comes to the tax aspect of selling a business.
It’s important to analyze the potential tax consequences for the sale of your business early on. If you’re even thinking about a sale, be sure to consult with a knowledgeable CPA or business tax advisor to avoid making potentially expensive mistakes that give too much of the proceeds to your silent partner, Uncle Sam.