When you are five years out from potentially selling your business, what planning should you be starting right now?
When you are five years out from potentially selling your business, what planning should you be starting right now?
Sometimes tax planning takes time. Sometimes you need to start years in advance. If you own a business, your tax planning should start today.
Is Your Business Structured for Sale?
Do you know how businesses are sold in your industry? Most privately owned businesses are acquired in a version of an asset purchase for tax purposes. What happens in an asset purchase? All of the assets of the seller are sold, one by one, to the buyer. Some of these assets (receivables, for example) generate ordinary income when sold. The majority of the gain is usually goodwill, a capital asset generating capital gains.
Most of the time, private sellers end up with mostly capital gains and some ordinary income from an asset sale. Cash-basis services businesses and manufacturing businesses that used bonus depreciation may have substantial ordinary income. Yet, 80-90% of the purchase price in private business sales is often taxed only at capital gains rates.
Federal taxes are not the only concern. Companies that do business throughout the country have state tax issues. If your business operates in multiple states, state tax planning may be the best investment you can make. Or it can be the one that looked good on paper, but no savings resulted. State tax planning requires two sets of facts to work simultaneously: income needs to be sourced to low-tax states instead of high-tax states, and business owners (individuals or trusts) need to reside in low-tax states.
Is Your Family Structured for Sale?
A family can also take tax planning steps today to increase their after-tax returns tomorrow. Families control their location, their balance sheet and their future choices.
Who owns the business today? Should that same person own the business when it is sold?
You can control where you live. Future sellers can greatly reduce their tax liability by moving from New York to Florida. With state tax rates exceeding 10%, the arithmetic is short: 10% of a $50 million sale is $5 million. If the sale of a business can be removed from a high-tax state – and the gain is not sourced to high-tax states – a family's tax savings can easily be millions of dollars.
Families also want to move business interests, or shift appreciation, outside of an individual's taxable estate. If individuals own the business, any growth in value will be included in their taxable estate. The easiest estate planning strategy is to take advantage of time: transferring interests today will almost always be less expensive than transferring in the future. It is relatively easy to transfer business interests out of a taxable estate at a discounted valuation, particularly using grantor trusts. This planning can eliminate a future estate tax problem more easily than any other technique.
My views, not those of Frazier & Deeter or Mobena. Not tax or legal advice; consult your own advisor.