Consider These Proactive Strategies for Minimizing Taxes
Selling a business is a significant milestone, often the culmination of years of hard work, innovation, and dedication. However, one of the biggest risks to maximizing the sale of your business is how much of a bite Uncle Sam is going to take out of that final offer — yes, I’m referring to taxes. When a business is sold, the proceeds are subject to various forms of taxation, including capital gains, ordinary income, and potentially state and local taxes. For this reason, it’s not enough to just focus on the total amount the buyer offers you, you must consider how much that you and your family get to keep after tax.
Before I share a few strategies on tax minimization, it’s essential to understand that there is a difference between tax deferral and tax mitigation (or minimization). Tax deferral typically allows the seller to enjoy reduced taxes in the short term and kicks the tax-liability-can down the road to a future date. An effective example of this strategy would be Deferred Sales Trusts. This is an arrangement where an investor sells appreciated assets — such as real estate, securities, or a business — to a third-party trust. In return, the investor receives specified future payments, known as installments or installment sale notes, over a set period. By utilizing a Deferred Sales Trust, investors can strategically defer capital gains taxes over time. Tax mitigation, on the other hand, seeks to permanently reduce the overall tax liability. Let’s explore some proactive strategies that minimize taxes when selling your business, ensuring you retain as much of your hard-earned wealth as possible.
1. Employee Stock Ownership Plan (ESOP)
An Employee Stock Ownership Plan (ESOP) is a unique retirement benefit plan that allows employees to become partial owners of the company they work for. In an ESOP, a trust is created and funded by the employer, which then purchases company stock on behalf of the employees. Over time, employees accumulate shares in the company as part of their retirement benefits. ESOPs provide employees with a stake in the company’s success, fostering a sense of ownership, loyalty, and alignment of interests between management and staff. Additionally, ESOPs offer tax advantages for both the employer and the employees, making them a valuable tool for succession planning, employee retention, and wealth accumulation.
When does it make sense?
- When a great company culture already exists, and future leaders are already being cultivated within the organization.
- The seller plans for this well in advance so that employees have time to buy into the company.
What are the tradeoffs?
- It can be complex and expensive to establish a plan and require ongoing administration.
2. Family Limited Partnership (FLP)
A Family Limited Partnership (FLP) is a legal structure that allows family members to pool their assets and operate a business together while retaining some degree of control and asset protection. In an FLP, one or more family members serve as general partners who manage the business and make operational decisions, while other family members become limited partners who contribute capital but have limited involvement in management. The general partners maintain control over the partnership, allowing them to make decisions regarding the business’s day-to-day operations and long-term strategic direction. FLPs are commonly used for estate planning purposes, as they can facilitate the transfer of wealth from one generation to the next while minimizing estate and gift taxes. Additionally, FLPs offer liability protection to the partners, shielding their personal assets from the debts and liabilities of the business. A Family Limited Partnership can help in transferring business ownership to family members at a reduced tax cost, while also providing some control over the business operations.
When does it make sense?
- For family-owned businesses where there is interest in passing it to the next generation.
What are the tradeoffs?
- It can be complicated and costly to set up, often requiring professional oversight.
3. Qualified Small Business Stock (QSBS) Exclusion
There is an exemption from capital gains taxes on the sale of a small business, known as the Qualified Small Business Stock (QSBS) exemption. The QSBS exemption applies to the entire sale price of the business, including any goodwill that is included in the sale. When your business qualifies, you pay zero capital gains taxes. Nada! Sound too good to be true? That’s because to qualify for this exemption, the business must be a C-corporation and have less than $50 million in assets.
When does it make sense?
- If your business qualifies as a QSBS.
What are the tradeoffs?
- It is limited to certain types of businesses and there are strict eligibility requirements.
4. Charitable Remainder Trust (CRT)
A Charitable Remainder Trust allows you to transfer some or all your ownership in your business (before sale) into a trust in exchange for you or your beneficiary to receive a portion of that account as income for life or specific period of time. The remaining portion of the account is irrevocably given to charity. The CRT is a tax-exempt entity, so it (and you) will owe no taxes when you sell any appreciated asset held within the trust, like business shares. Instead of paying a big chunk of change to Uncle Sam, you get to reinvest all the proceeds from your sale within the trust. You’ll receive annual distributions from the trust, and when the set income period ends, whatever is left goes to your favorite charity or charities.
When does it make sense?
- For philanthropic business owners who want to support charitable causes.
- There is a need or desire for a guaranteed income stream.
What are the tradeoffs?
- Any assets that you place into the trust cannot be retrieved once you put them there. This reduces how much you’re able to access immediately from the business sale because you can only withdraw a percentage of trust assets every year — typically between five and 15% of the trust’s value, according to an IRS-approved formula
- Complex to set up — often requires professional oversight.
The Importance of Proactive Planning
Each of these tax minimization strategies require careful consideration and professional advice to navigate the complexity of your unique situation. Regardless if you’re contemplating an ESOP, Family Limited Partnership, QSBS Exclusion, CRT or something else, it is crucial that you start planning for this proactively, ideally two to three years out, and not wait until you’re 90 days out from close because at that point you may have missed the opportunity window to implement these strategies and minimize your tax burden.
The sale of your business is more than a financial transaction; it’s a pivotal moment that determines your success in transitioning to the next phase of your life – like retirement! For that reason, it’s essential that you start to build your sale team early which often includes a CPA, an estate planning and business attorney, a financial advisor with a specialty in this area, and a business broker who can tailor these strategies to your specific situation. By understanding and implementing the right strategies at the right time, you can significantly reduce your tax burden, retain more of your wealth, and ensure that the legacy of your hard work endures for years to come.
Emma James is a financial planner at Rosell Wealth Management located in Bend.
Rosell Wealth Management offers a proactive planning process called the 6% Advantage that helps successful business owners identify and capture the 6 critical opportunities that exist when selling their companies so that they can ultimately live their retirement years with confidence and purpose.
Call us at 541-385-8831 to schedule a complimentary meeting with our team to learn more or visit our website RosellWealthManagement.com/begin-a-dialogue.
Investment advisory services offered through Valmark Advisers, Inc. an SEC Registered Investment Advisor Securities offered through Valmark Securities, Inc. Member FINRA, SIPC 130 Springside Drive, Ste 300 Akron, Ohio 44333-2431. 800-765-5201. Rosell Wealth Management is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.
