There’s a lot to consider when selling a business and tax planning is at the top of the list. When Click here you sell a business or business assets at a profit, the IRS expects to receive a cut in the form of capital gains tax. That could potentially result in a larger-than-expected tax bill. If you’re in the initial stages of planning your exit, it’s important to know how to avoid capital gains tax on a business sale.
For more help managing capital gains taxes or any other financial issues, consider working with a financial advisor.
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How Is the Sale of a Business Taxed?
The sale of a business or business assets is generally subject to capital gains tax. Capital gains tax is a tax that’s assessed when you sell an asset for more than its basis, or what you paid for it. The IRS levies two types of capital gains tax: short-term and long-term.
The short-term capital gains tax rate applies to assets held for less than one year. Short-term capital gains are taxed as ordinary income. So whatever tax bracket your business normally falls into would apply when calculating short-term capital gains tax.
Long-term capital gains receive more favorable tax treatment. The long-term capital gains tax rate applies to assets held for longer than one year. The current long-term capital gains tax rates are 0%, 15% and 20%, depending on income.
When applying capital gains tax rules to the sale of a business, the IRS typically looks at the individual assets of the business. That’s assuming that your business is structured as a sole proprietorship, partnership or limited liability company (LLC). So instead of seeing your business as a single asset or entity, the IRS looks at all the assets the business owns, including:
Real estate
Equipment or machinery
Property leases
Raw materials and supplies
Intellectual property, such as trademarks, patents and copyrights
Again, the capital gains tax rate you’ll pay on the sale of those assets depends on how long you’ve held them. It’s also important to note that certain assets, such as inventory or accounts receivable, are taxed as ordinary income rather than capital gains.
How Allocation of Sale Price Affects Taxation
how to avoid capital gains tax on business sale
When you’re working out a purchase agreement with a buyer, part of the negotiations involves choosing a sale price that applies to each tangible and intangible asset of the business. What you’ll pay in taxes for the sale of a business can hinge largely on how you allocate the sale price of individual business assets.
Here’s why that matters. The purchase price you set for each asset can determine your capital gain (or capital loss) on the asset. It also establishes the buyer’s basis for each asset that’s purchased. While that’s less important for your tax situation, it’s important to note that the buyer may also be angling for the most favorable tax treatment when negotiating prices.
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