Selling a business is a significant event for any entrepreneur or business owner. For many business owners, the company reflects their life’s work and represents their most significant financial asset. While many factors contribute to the success of a sales transaction, proactive tax planning can be an integral tool to aid maximization of value for the owner. The following are four tax considerations that business owners should consider when contemplating a transaction.
1. Sell-Side Tax Due Diligence
During the transaction process, experienced buyers will scrutinize the company’s historical tax practices and procedures to identify potential risk areas for the buyer. Identification of material risk items can negatively impact the seller, including purchase price reductions, extended escrow holdbacks or even the termination of the transaction entirely.
Conducting tax sell-side due diligence before going to market allows the company to uncover risk areas and take action to eliminate the issue or minimize the exposure risk. By proactively identifying and addressing issues, the company is better prepared to respond to inquiries from the buyer, reduce the potential for unknown problems to arise during the transaction process, support value maximization and, ultimately, a swifter closing process.
2. Pre-Transaction Tax and Wealth Transfer Planning
Pre-transaction income and transfer tax considerations should be an integral component of any effective sales process to ensure maximization of value for the owner. Typical income and transfer tax mitigation strategies include:
- The use of trusts.
- Transferring ownership interests to family members or family partnerships (often at a discounted valuation).
- Preferred charitable giving structures.
These and many other strategies take months, or even longer, to implement effectively, so the business owner must plan well ahead of any contemplated transaction.
3. Transaction Structure
A significant tax consideration when you sell your business is the transaction structure. The seller can structure the business sale in several ways, including the sale of assets, the sale of equity or the sale of equity with an election to treat as an asset sale for income tax purposes. Depending on the type of business being sold (e.g., partnership, S-Corp, C-Corp), and the tax attributes inherent in the business, each transaction structure may produce significantly different tax consequences for the seller. Before starting a sales process, the business owner needs to understand the relative tax consequences of potential structures. By understanding the relative tax consequences, the business owner will be in a better position to negotiate the terms of the deal to maximize their after-tax proceeds.
4. Purchase Price Allocation
When structuring the sale of a business as an asset sale (or a deemed asset sale), you must consider the allocation of the purchase price. The purchase price allocation is when the seller and buyer agree to assign value to the business’s assets for income tax reporting purposes. Generally, a seller will prefer to maximize the purchase price allocated to intangible assets as the resulting gain is taxed at preferential capital gains tax rates. On the other hand, the purchaser generally prefers to allocate the purchase price to tangible assets (e.g., accounts receivable, inventory, depreciable property, etc.) as it results in the recovery of its investment at a faster rate but may generate a gain for the seller that is taxed at less preferred ordinary tax rates. Much like the overall transaction structuring, understanding the tax implications of the purchase price allocation will enable the business owner to be in a better position to negotiate the terms of a transaction and optimize their tax position.
If you need assistance preparing your business for a sale, the Moore Colson Tax Practice can help. Our professionals can provide expert guidance in proactive tax planning and strategies to maximize your company’s value. Don’t hesitate to contact us for more information.