Let’s face it: taxes are high for business owners in the United States. When you sell a business, here’s what you can expect to owe the government:
- Federal capital gains taxes
- State capital gains taxes (which have increased in many states in recent years)
- Net investment income tax (an additional 3.8% on investment income)
- State income taxes (also increasing for many investors around the country)
- Business and personal taxes (double taxation) if you own a C-corporation
Most sellers will pay 35-45% taxes when they sell an asset or a business outright.
The amount you pay in taxes will also depend on how you structure the sale of your business. You might be tempted to choose the type of sale that simply gets you the highest selling price or is the most convenient. However, if you ignore the tax implications of your sale, you might end up with less money in your pocket, even with a higher selling price.
Friends don’t let friends pay taxes they can avoid. That is why we are here to help you understand the difference between a stock sale and an asset sale and how a Deferred Sales Trust can help you defer and even reduce your taxes, no matter the structure of your sale.
Stock Sale vs. Asset Sale
First, it is important to mention that a stock sale can only be used by C-corporations or S-corporations (with restrictions). If you are a sole proprietor, a partnership, or an LLC, you can only conduct an asset sale (since your company doesn’t have stock).
Stock Sale
In a stock sale, you sell your entire company, not just its assets. Everything in your business is wrapped up in a corporate shell. You don’t have to assign a price to each asset because it is all included. Here are some key points about a stock sale and the benefits and drawbacks for buyers and sellers.
- The buyer gets the entire business, including its assets, contracts, employees, intellectual property, goodwill, and liabilities.
- Because the business remains intact, operations can continue, and contracts tend to stay in place.
- Buyers tend to shy away from stock sales because they assume all current and future liabilities with a stock sale. This means they could be sued for something that occurred before purchasing the business.
- From a tax perspective, sellers usually prefer a stock sale as they get the more preferential capital gains tax treatment rather than owing ordinary income tax.
- On the other hand, a stock sale is less beneficial to buyers from a tax perspective. They lose the ability to gain a “step-up” in basis for the assets they acquire.
Asset Sale
In an asset sale, the buyer purchases individual assets, but the seller keeps possession of the legal entity. Here’s what to know about an asset sale:
- The buyer selects which specific assets they want to purchase. Unwanted liabilities stay with the seller.
- The seller must allocate the sale price among all the separate assets, such as goodwill, hard assets, and accounts receivable.
- Existing contracts may need to be approved by the third party for transfer.
- The buyer gets tax benefits from asset depreciation.
- The seller is taxed at the capital gains tax rate for intangible assets like goodwill, but they pay ordinary income tax on the proceeds from selling “hard” assets like property or equipment.
- If the company is a C-corporation, the seller may pay double taxes; the corporation is taxed at the corporate level, and then the owners are taxed again when the proceeds transfer out of the corporation.
What is a Deferred Sales Trust?
A Deferred Sales Trust (DST) is a legal, proven strategy to allow sellers to sell highly appreciated assets and defer capital gains taxes so they can use the money to generate income or wealth more rapidly.
When using a Deferred Sales Trust, instead of selling directly to a buyer, the business owner sells the assets or stocks to an independent, third-party trust. The trust gives the seller a promissory note, sells the business to the buyer, and takes receipt of the proceeds.
Because the seller has not received any direct profit from the sale, they don’t owe any taxes. The trust then reinvests the proceeds on behalf of the seller and distributes the earnings in regular installments as agreed upon before the sale. This lets the seller reinvest 100% of their profits and maximize their return. The seller only pays taxes on the portion of the proceeds they receive as installments each year.
What is the Role of a DST in a Sale?
You can use a DST no matter how you structure your sale. It doesn’t matter if you are a C-corporation, a partnership, a sole proprietor, or an LLC. Even if your company has multiple owners, and not every owner wants to use a DST, you can still make it work for you. A Deferred Sales Trust will work with either a stock sale or an asset sale.
Whether you want to retire or reinvest to start the next phase of your life, a DST can increase your income and help you grow your wealth faster. When it comes to selling a business, it’s not the selling price that matters; it is how much you actually walk away with. At the end of the day, using a Deferred Sales Trust means more money for you.
As you can tell, buyers and sellers have different motivations when buying or selling a business. When sellers face steep taxes, they might feel pressure to raise their sale price or push for a sale structure that doesn’t benefit the buyer. If you can use a DST to offset some of the tax challenges, finding middle ground and agreeing with a buyer can be easier, reducing your stress and getting a deal faster.
If you are looking to retire or sell your business, reach out to a Deferred Sales Trust trustee today. Don’t get too far into your negotiations before considering the tax implications of your sale. If you want to know how to avoid capital gains taxes when selling a business, an experienced trustee can work with you and your team of advisors to help you create an exit plan that increases your income and grows your wealth faster.