After years of building your business, the last thing you want is to see a significant portion (think half) of your hard-earned proceeds go to Uncle Sam when you sell. The challenge is that many business owners focus so intently on maximizing their sale price that they overlook critical tax planning strategies that could save them hundreds of thousands to millions of dollars.
The truth is that how you structure your sale can be just as important as how much you sell for. With proper planning, you can significantly reduce your tax liability and keep more of the sale proceeds in your pocket after closing. The key is starting early, since most tax strategies require action well before you begin the sales process.
In this article, we’ll explore and review five proven strategies to minimize your tax liability when selling your business. While these approaches can be powerful (and may seem simple at face value), they should be implemented with the guidance of experienced advisors who have been through multiple deals themselves, and understand both the tax implications and how they align with your overall exit goals and the deal dynamics.
1. Installment Sale to Spread Out Tax Liability
An installment sale allows you to receive payments for your business over multiple years, which can provide significant tax advantages compared to receiving the entire amount in one lump sum.
How It Works:
- You receive payments over time (typically 3 to 5 years, but can be much longer) rather than all at once, using a Seller Note.
- You only pay taxes on the portion of the gain received each year.
- This can help keep you in lower tax brackets and reduce your overall tax burden, especially if this becomes your primary/only source of income.
Why It Matters:
By spreading your income across multiple tax years, you may avoid being pushed into the highest marginal tax brackets. This type of structure is typically beneficial from a tax perspective, and can also be a good tool to incentivize a Buyer who may not have access to all the cash they need to close. They have a chance to spread out the payments, and you can less tax overall. Additionally, this approach typically provides interest income to you as the Seller during the period.
Pro Tip: Consider negotiating higher interest rates on the installment payments to compensate for the delayed receipt of funds. This can increase your total return while still providing tax benefits through income spreading.
For more tips on how to get through Due Diligence read our article How to Survive Due Diligence Without Breaking a Sweat.
2. Section 1202 Qualified Small Business Stock (QSBS) Exclusion
If your business is structured as a C-corporation and meets certain requirements, you may be eligible for one of the most powerful tax advantages available: the Section 1202 Qualified Small Business Stock (QSBS) exclusion.
How It Works:
- Allows for exclusion of up to 100% of capital gains from federal income tax.
- Applies to eligible small business stock held for more than 5 years.
- Maximum exclusion of the greater of $10 million or 10 times your basis in the stock.
- Business must be a qualified C-corporation with assets under $50 million when stock was issued.
Why It Matters:
These tax savings can be substantial, potentially eliminating federal capital gains tax entirely on the sale. This can make a C-corporation structure much more attractive than pass-through entities for businesses planning an eventual sale. This kind of structure and benefit is more common for companies who raise capital via external investors (in addition to other C-Corp benefits).
Pro Tip: If you’re currently structured as an LLC or S-corporation, consider converting to a C-corporation at least five years before a planned sale to potentially qualify for this exclusion. However, this is a complex strategy and will only really work under the right circumstances, especially given the nuances of C-Corp taxation. A review with your tax advisors will help confirm if this makes sense for you.
3. Leverage Charitable Remainder Trusts (CRTs)
A Charitable Remainder Trust (CRT) offers business owners a powerful tax planning strategy when selling their company, providing immediate tax benefits for those with plans to support charitable causes.
How It Works:
- Transfer business interests to a CRT before finalizing a sale (timing is critical).
- When the business sells, the CRT pays no immediate capital gains tax on the proceeds.
- You receive an income stream from the trust for a set period (up to 20 years) or for life.
- You get an immediate charitable deduction based on the present value of the eventual donation (this is key since you want the deduction to be in the year of the gain on sale).
- After the income period ends, the remaining assets go to your chosen charity.
Why It Matters:
This approach allows you to defer capital gains taxes, reduce your current income tax through the charitable deduction, create a reliable income stream, and support causes you care about. It’s particularly valuable for highly appreciated businesses where capital gains taxes would otherwise take a significant chunk out of your net proceeds.
Pro Tip: Consider using a portion of your income stream from the CRT to fund an insurance policy held by an irrevocable trust. This creates a wealth replacement strategy that can provide your heirs with tax-free proceeds potentially equal to what they would have received had you not donated the assets to charity. Plenty of other planning tips exist as well – check with your Wealth Advisor.
4. Purchase Price Allocation Structure
How you allocate the purchase price among various business assets can significantly impact your tax liability. Different assets (tangible vs. intangible) are taxed at different rates, so strategic allocation can result in substantial tax savings.
How It Works:
- Assets like goodwill and noncompetes qualify for lower capital gains rates.
- Depreciable assets that were written off previously will likey be subject to depreciation recapture at ordinary income rates – for equipment-heavy businesses, this can become a big number!
- Inventory is typically taxed as ordinary income – depending on the normal inventory levels of your business, this is another area that can generate a significant liability. With careful planning, you can work to reduce this amount down before sale.
- The buyer and seller must agree and file consistent purchase price allocations on Form 8594.
Why It Matters:
By allocating more of the purchase price to assets that receive favorable tax treatment (like goodwill) and less to assets taxed at higher rates, you can potentially reduce your overall tax burden while the buyer can still optimize their future depreciation deductions.
Pro Tip: While the IRS requires that allocations reflect fair market value, there’s often flexibility within reason when a Buyer and Seller agree on the values of those assets. Work with your CPA and M&A attorney to negotiate an allocation that benefits both you and the buyer. Remember that the buyer often wants the opposite allocation that benefits you, so be prepared to make this a key negotiation point.
For more information, read our article on the role of a CPA in a business sale.
5. Consider a Tax-Free Reorganization
If you’re selling to a larger company, you may be able to structure the transaction as a tax-free reorganization under Internal Revenue Code Section 368, where you exchange your business interest for equity in the acquiring company.
How It Works:
- You receive stock in the acquiring company instead of cash.
- No tax is due until you sell the acquired company’s stock (up to you).
- Must meet specific requirements under various subsections of Section 368.
- Can include some cash out as well (often called “boot”) but too much cash will trigger taxes.
Why It Matters:
This strategy allows you to defer taxes until you sell the acquiring company’s stock, which you could hold indefinitely in your Estate, or sell gradually to manage your tax liability. It’s particularly valuable if the acquiring company is publicly traded, giving you liquidity options without immediate tax consequences.
Pro Tip: Consider negotiating for preferred stock with certain liquidation preferences or dividend rights to provide more security while still qualifying for tax-free treatment. Also, if you believe the acquiring company has strong growth potential, this approach allows you to participate in that upside, or “another bite at the apple”.
Final Thoughts
Tax planning for a business sale is not a one-size-fits-all process. The optimal strategy depends on your specific situation, including your business structure, personal financial goals, timeline, and the profile of potential buyers. Keep in mind that these are only 5 strategies – many more exist and may be available to you. All can be uncovered and utilized with the right team on your side.
Read more about the types of buyers for your business here: The 6 Types of Buyers You Need to Know Before Selling Your Business.
The key is to start planning early, ideally at least two to three years before you intend to sell. This gives you time to implement structural changes, meet holding period requirements, and position your business to keep more of the proceeds after closing.
Remember that while reducing tax is important, it shouldn’t be the only factor driving your exit strategy. The best approach balances tax efficiency with your other objectives: maximizing overall value, finding the right buyer, ensuring a smooth transition, securing your financial future, and most important – CLOSING THE DEAL.
Ready to develop a tax-efficient exit strategy? Reach out to our team to discuss how we can help you keep more of what you’ve built when it’s time to sell your business.
