Tax Opportunities & Pitfalls When Exiting a Business

Posted on March 6, 2014 · Posted in Blog

Guest Post By Wesley Middleton | Managing Partner, MiddletonRaines+Zapata, LLP

Tax Planning Exit StrategyWhen planning to sell your business, a very natural conflict arises between the buyer and the seller. The buyer generally wants to buy the assets of the company and the seller generally wants to sell the equity, whether it be stock or other equity units.  Today, the ordinary tax rates on an asset sale can be double that of the capital gains rates of a stock sale.   This is just the Federal rates on the transaction, not to even speak of the potential state sales, use or other transfer taxes.  There are several strategies that may be used to create a more favorable tax situation, depending upon the situation and the type of entity that you own.

  1. Do you plan on donating something to charity? If so, consider donating some of the stock to a charity.  If you can avoid the step transaction, you will receive an income tax deduction and the charity won’t pay tax on the gain.
  2. If the donation to the charity doesn’t work for you, consider using a charitable remainder trust (“CRT”).   You would get an income tax deduction in the year of the donation that generally will offset the gain on the sale, and the stream of payments from the CRT could put you close to the same after tax position had you sold the stock and financed the sale.
  3. If you plan on retaining an equity interest in the new entity, consider using a tax-free reorganization to close the deal. In certain tax-free reorgs, you can receive some cash in the form of taxable “boot” without jeopardizing the tax-free status.
  4. Consider selling the stock to an employee stock ownership plan (ESOP). Depending upon your status as an S or C corporation, each will have different results and could work in your favor.
  5. Do you have a service business, or would your customers follow you to whatever business you went to? Your goodwill could be “personal” and not that of the company; this will help you avoid the double taxation trap of selling C corporation stock. (Martin Ice Cream Company v Commissioner 110 T.C. No. 18, 1998)
  6. Weigh the costs of making the S-election. It may work in your favor even with the built in gains tax.
  7. Pay close attention to the sales price allocation if it is an asset sale. Form 8594 will need to be prepared by both parties.  The allocation of the sales price can affect your tax on the transaction.
  8. If you are considering acquiring a franchise or starting a new business, investigate the use of your retirement plan to purchase a franchise or start-up business.  When you are ready to sell this business, a stock sale could be tax deferred!

All of these options can be very complex and should only be considered and evaluated under the professional advice of a CPA or an attorney.  You should NOT try to do these on your own; proper structure and compliance is paramount to withstanding a challenge by the IRS.

Contact MiddletonRaines+Zapata, LLP to learn more about tax opportunities at every stage of your business.

Any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter addressed within. Any opinions contained herein are those of the author and do not necessarily represent those of MiddletonRaines + Zapata, LLP.