Selling a business marks a pivotal moment for entrepreneurs and business owners. Often, the company embodies their dedication, determination, and hard work. It also serves as their most significant financial asset. Therefore, a sale may offer a sizable reward and the opportunity to create a post-sale family legacy and pursue life’s next adventure.
Proactive Tax Planning Strategies
While many factors contribute to the success of a sales transaction, proactive tax planning strategies can be an integral tool to enhance the value realized by the owner. Considering this well in advance, even several years before your projected selling timeline, can enable you to proactively take the essential measures to optimize your company's positioning for a lucrative sale. Here are four key tax considerations to think about when deliberating a transaction.
1. Sell-Side Tax Due Diligence
Throughout the transaction proceedings, seasoned buyers meticulously assess the company's historical tax practices and procedures to identify potential risks. The detection of significant risk factors can adversely affect the seller, leading to purchase price reductions, prolonged escrow holdbacks, or the termination of the transaction.
Engaging in sell-side tax due diligence before entering the market allows the company to uncover risk and implement measures to mitigate or eliminate that exposure. By enlisting the services of an independent third-party provider to conduct a thorough tax analysis from the buyer's perspective, the company will then be better prepared to respond to buyer inquiries. Additionally, it reduces the likelihood of unexpected problems emerging during the transaction process, facilitates value maximization, and expedites closing processes.
2. Pre-Transaction Tax and Wealth Transfer Planning
Incorporating pre-transaction income and transfer tax considerations is an integral component of any effective sales process to maximize value for the owner. Common strategies for mitigating income and transfer taxes include:
Utilizing trusts.
Transferring ownership interests to family members or partnerships, often leveraging discounted valuations.
Implementing preferred charitable giving structures.
These and numerous other strategies require significant time, often months or longer, to implement effectively. Therefore, business owners must plan well in advance of any anticipated transaction.
3. Transaction Structure
When selling your business, a significant tax consideration is the transaction structure. Sellers have several options, including selling assets, equity, or a hybrid of both by making an election for income tax purposes. Each transaction structure may produce significantly different tax outcomes for the seller depending on the type of business and its inherent tax attributes. Before initiating the sales process, the business owner must understand the relative tax implications of each structure to negotiate deal terms more effectively 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 carefully consider the allocation of the purchase price. This is one of the most complex parts of an asset sale as it entails the seller and buyer agreeing to assign value to the business's assets for income tax reporting purposes. Typically, sellers prefer to maximize the allocation to intangible assets because any resulting gains are taxed at preferential capital gains tax rates. Conversely, purchasers often prefer allocating the purchase price to assets such as accounts receivable, inventory, and depreciable property because it allows for a faster recovery of their investment. However, this may generate gains for the seller, which are taxed at less preferred ordinary tax rates. Understanding the tax implications of purchase price allocation enables the business owner to negotiate the transaction terms more effectively and optimize their tax position.
Here to Help
If you need assistance preparing your business for a sale, we are here to help. We build value-added relationships with each client to understand their business structure to provide solid solutions, and our approach offers direct access to the firm's decision-makers. Our innovative cross-functional services help businesses address the challenges ahead. Contact us to let us know how we can best support you.