Capital Gains Deferral In A Business Sale
Topics: business broker, merger and acquisition, sell a business, succession planning, defer capital gains tax
The sale of business is a challenging and difficult transaction with several complicated aspects. Whether it’s the complete sale of a business or simply the sale of a partial ownership interest in a company, one of the most troubling issues created by this disposition is the manner in which capital gains and other taxes are addressed. There are not many options available to a business owner, and the few that are come accompanied by complex rules and regulations. There are also restrictions that can increase future risk and possibly trigger IRS penalties.
We are always looking for ways for our business sellers to maximize their transaction proceeds while keeping as much possible through the use of intelligent tax planning and deal structure. I asked Dan Carroll from Brook Hollow Financial to explain a unique way to defer capital gains taxes that are the result of a business sale.
Large Tax Bill Due upon Sale
Capital Gains, Depreciation Recapture and even Income taxes may be levied against the proceeds of the sale of the business. Depending on the initial amount invested and how much the business has grown, these taxes can consume much of the sale price. Currently the Federal Capital Gains Tax stands at 15%. Most states have a Capital Gains Tax as well, with the total amount often exceeding 20% of the gain. We believe that these rates will have near term upward pressure caused by the need for the Treasury Department to make up for the $800 billion shortfall that will result from the repeal of the Alternative Minimum Tax. Other taxes, particularly if held in a ‘C’ Corp., can exceed 60% of the transaction.
Loss of Regular Income
When a business is sold, the owner’s cash flow stops as well. Therefore, the amount of money that was being produced needs to be replaced. Without this regular income, former business owners are left with a significant gap in what they receive each month and must alter any plans or budgets accordingly.
What to do with the Proceeds
Another major challenge that a business owner will face is what to do with the proceeds of any sale. There are many ways to put this money to work for you, but this often means accepting significant risk and investing in markets without much experience. Alternatively, sellers might mitigate risk, but only at the cost of getting a very low return. Either way, inadequate returns and potential loss of capital are serious risk factors that must be considered.
Need to Mitigate Future Risk
Among the challenges presented by investing the new capital is that there may be different goals for the individual at this stage of his or her career. If the sale is prompted by a desire to move away from daily management and responsibility, or simply to cash out at a good time in the market, the owner may want to revisit his or her goals. A review of the financial needs and expectations may reveal a requirement for total investment certainty. While these alternatives do exist, most do little to provide a reasonable return and can make planning more difficult with these limited resources. The need and desire to mitigate future risk should play an important role in any decisions about your investment plans.
The Traditional Business Sale - Cash Transaction
The cash transaction option is fairly straightforward. The seller is paid cash from the buyer. After any loans or other debts are paid, the funds are then made available to the seller. At this point, the seller must pay federal and state taxes on the proceeds, and then the remaining balance is left to invest. This drastically reduces the principle and lowers any future returns. The stock market and other liquid investments carry very significant market risk, and the individual could lose some or all of the money. On the other hand, the individual could place the money into a guaranteed investment such as a certificate of deposit, but the returns will drastically lag other possible alternatives. Investing on your own requires some planning and active management of the portfolio, but more importantly, it may provide for unpredictable future income necessary to manage and care for an investor and his or her family.
Another Approach - The Installment Sale
The Installment Sale is a mechanism that has been available since the 1930’s. In this type of transaction, the buyer of a business agrees to pay the seller a certain amount of money over a fixed period of time. Under this approach, the IRS has ruled that only the amount of distribution in any given year is subject to any applicable taxes in proportion to the total due. The problem here had been reliance upon the buyer to continue to make the payments promised. Often times the business is run poorly and is no longer producing enough revenue to make the promised payments. There has always been recourse in these transactions, so that if the buyer did not live up to his obligation, the seller could foreclose and reclaim ownership of the business. However, this offered little protection if the business has not been run properly or the value lowers for other reasons, since the original seller would now reclaim a much less valuable business.
An Improved Approach - The Installment Sale with Guaranteed Annuity Payments
There is a way to ensure that these types of transactions could still be utilized while eliminating the possibility of default. The transaction takes place as described above, only there is a second transaction that occurs simultaneously. At the time of closing, the buyer purchases an annuity from an A+ rated Annuity company. Therefore the seller receives a guarantee that regardless of the future strength of the business, the payments will be made as agreed upon, and all of the tax deferral benefits remain intact.
The benefits of this type of transaction are as follows:
Seller is able to sell the business without future risk
Tax-deferral creates much greater taxable equivalent return
Flexible planning allows for specific plans tailored to individual needs
Stabilizes future income with certainty for life
Much larger total benefit over time - guaranteed
Payments can continue to pass on to heirs in the event of death
Eliminates need for expensive life insurance
Requires no management responsibility
There are no direct or on-going fees
Expedited closing
A simple way to look at this plan is to compare it to an IRA. With the IRA your investments get to grow on a tax deferred basis for many years and you get the benefit of earning investment returns on the amount not paid in tax. When you draw the funds out of the account, you are then taxed at your then current rate. With the guaranteed annuity installment sale, you may elect to take a portion of the business sale proceeds at close and pay all of the appropriate taxes on that portion.
You then could structure the guaranteed annuity to begin paying you a certain amount starting in 5 years for another 20 years. The investment would be allowed to grow tax deferred for that 5-year period. When you started taking distributions, you would be taxed at the rate you would have been from the original sale transaction. The important thing to remember here is that instead of receiving the entire distribution at closing and paying a huge tax bill up front, you are taking 1/20th of the distribution each year and paying 1/20th of the tax. The remaining portion of the deferred tax stays invested and earns income over the 20-year period. This substantially increases your return on the deferred portion of your sale proceeds.
This mechanism is a great way to secure your proceeds with guaranteed payouts, no ongoing involvement or management responsibility, and beneficial tax treatment. This will ensure the highest possible taxable equivalent return when compared to any fixed-income, guaranteed investment. Remember in a business sale the important number is how much you get to keep.
Dave Kauppi is president of Mid Market Capital, Inc. MMC is an M&A advisory firm focused on middle market strategic business sellers. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630)325-0123 davekauppi@midmarkcap.com or www.midmarkcap.com
Previous Articles Highlighter:
How To Avoid Common Offshore Real Estate Investing Mistakes (1)
It can enhance your existent financial portfolio. But, ensure that you play by the rules pertaining to offshore real estate investments. Conduct thorough research and do not hesitate to call in the professionals.
Are Penny Stocks For You? (2)
Topics: business, finance, penny stocks, penny stock, penny, stock, companies Have you ever wondered if what you know about penny stocks is accurate? Consider the following paragraphs and compare what you know to the latest info on penny stocks.
Advice Of A Stock Broker (3)
Topics: stock broker, a stock broker, broker, advice, subscribe The following article covers a topic that has recently moved to center stage--at least it seems that way. If you've been thinking you need to know more about it, here's your opportunity.
Low Risk Stocks Financial Planning (4)
Careful reading to the end virtually guarantees that you'll know what they know. Stocks are a great way to secure your family's financial future. From braces, to college, to weddings, and retirement you will find a way to pay for all of these things and a few of life's unexpected emergencies along the way.
How To Get An Adverse Credit Loan In A Hurry (5)
Collateral is something that the borrower owns which is promised to the bank in the case that the poor credit finance are unable to be repaid in the scheduled manner.
Common Stocks As Long-Term Investments Explained (6)
Their cupidity and stupidity had done them in. All of this gave the stock market a bad name; and it took several years for lessons learned at great pain and cost to sink in.
Debt Settlement And Credit Repair: The Perfect Combo? (7)
Debt settlement works well for some and can reduce larger debts to as much as 60 percent. Two of the major drawbacks are the fees charged by debt settlement companies and the damage it does to your credit score.
Where Are The Top Homes For Sale In Galveston County? (8)
Houston is only a stone's throw away, so you can work in the city and commute home every night. As prices in beach cities and islands, like Galveston, began to rise in the late 20th and early 21st century, many families moved to League City to cut costs.
The CIA's Guide To International Investing (9)
But it goes to show that the biggest driver of any economy is what's going on inside a country, not how much it exports. Just like the Japanese culture, there are many unique aspects to the Japanese economy.
Are Investments For You? (10)
The question remains, because there are so many out there who are not yet investing, with so many reasons to invest, are you ready to invest? Here are a few situations in which if you don't think you are ready to invest you may need to revisit your opinions and decide that ready or not, you need to invest.
5 Myths Of Credit: Don't Make These Mistakes! (11)
If they're not, you might as well save some money if you're going to end up with the same net result. Myth #4 Accurate Information Cannot Be Removed From a Credit Report.
Helpful Tips For Finding The Best New Places To Live In Houston (12)
Nothing is worse than falling in love with a house and then learning that you don't have enough money for a down payment. Tip # 3: Consider looking outside of the city.
Real Estate Made Easy (13)
Many people jump into buying a home without preparing for the task. Organizing yourself with seven simple steps can make the Hendersonville, NC real estate market easier to manage.
Unlocking Your Cash Flow Code (14)
This sounds strange, doesn't it? Wouldn't you automatically assume that everyone in business has a healthy relationship with money? Unfortunately, this is far from being the case. Self-Sabotage In a recent poll conducted by our firm, more than 90 percent of the small business owners we polled actually had negative money beliefs.
Mortgage Advice For Modern Man (15)
Even today, within the households of the mind blowingly rich around the world, gold bullion is preferred as a tangible commodity. The royal palaces and temples of ancient Mesopotamia may well have had no idea just what they were starting when they initially provided secure places for the safe keeping of commodities such as grain.
How You Can Learn 3 Important Lessons In Achieving Financial Success (16)
With positive cash flow and profit earn, she will develop and build another of his business and invest in real estate. With success in her home based business, own business and real estate, Jane cash flow increases and he finally becomes financially successful.
Life Insurance Policies - Protecting Your Future Today (17)
Term life insurance policies last for a set period of time: the term. There is no investment element and the premium tends to be cheaper than whole of life policies as a result.
An Ounce Of Medical Insurance Is Better Than A Pounds Worth Of Treatment (18)
Medical insurance coverage, just like many other forms of personal insurance protection, can be tailored to suit your individual circumstances very closely. Your first step in assessing what type of policy is suitable and appropriate for your family and youself, is to define what you actually need to be covered for.
Safeguarding Your Mortgage With A Life Insurance (19)
This decrease in life cover over time makes such policies even cheaper than non-mortgage insurance policies as the risk to the insurance provider is reduced. You do need to check to make sure that any decreasing mortgage term assurance policy will always cover any outstanding mortgage throughout the life of the mortgage.
Look For The Best Deal, Save Big Money (20)
Paul Dubsky is director Foreign Currency Exchange Services Ltd. The company is focused on being able to offer really friendly currency exchange rates www.foreigncurrencyexchangeservices.co.uk We believe we are the only company which offers special rates to Senior Citizens.
Newer Articles Highlighter:
Term Life Insurance - Who Says Insurance Has To Be Expensive? (1)
Term life insurance comes in many different forms and probably we come across it most often when buying a home. Here we have a mortgage for an amount that we know, that is going to last for a term that is set at the outset so it becomes very easy to see how much and for how long we need an insurance policy to cover the debt in the event of our death.
Commercial Real Estate Financing For Business Growth (2)
By applying basic rules of thumb, and not investing beyond certain thresholds, investors can increase their chances of sticking to projects that are within their means. With the use of specialized software, this process can be further streamlined, allowing financiers to quickly weed out which projects are potentially unprofitable.
Selecting A Good Price For Your Home Purchase (3)
How much are you able to pay? These numbers may vary depending on the transaction at hand. For example, for a multitude of great reasons, you may absolutely want the house.
Commercial Property Analysis: Accurately Predicting Earnings (4)
Topics: investment property, property investment, real estate investment property Commercial property real estate is a difficult niche of the real estate market, but it has the potential to be much more profitable than working simply in the area of residential real estate.
Investment Property Software The Easy Management Tool (5)
If you are making just a few small real estate ventures, you can probably manage your property with a simple method of keeping track of them. But when you start juggling multiple investments on a larger scale, you may not have the time to stay closely acquainted with all of your investments.
How To Earn Money From A Real Estate Syndicate (6)
If you are in the 40 percent bracket, you pay $200 per year on the $500 which is taxable and you keep $800 out of the $1,000 distribution. Ten percent distribution may mean in one case 10 percent take home pay.
How Downpayment Assistance Works (7)
They do this by simply giving back to a part of their proceeds to the buyer at the time of closing. There are limits, however, on how much assistance a seller may provide, depending on the kind of loan the buyer is obtaining.
Why People Are Moving To Austin (8)
And the best part of it all is that everyone is just fine with each other. It is often that a mix of all these people will be at different tables a t a coffee shop and everyone respects each other, no matter which way you decided to go.
Should Your First "House" Be A Duplex? (9)
In most areas a duplex leads to a lower monthly payment but there are a few real estate markets where the opposite is true. - Increasing Your Future Real Estate Purchasing Power Besides the advantages due to a lower mortgage payment there is another advantage over buying a duplex first.
Residential Investment Property Acquisition For Profit (10)
This is a bleak scenario, but like recession, not very likely according to many analysts. Those who have failed to invest, or are themselves busy paying off their first house, can be forgiven if they don't look favorably on the stalling market.
Commercial Real Estate Financing Basics (11)
Residential property generally appreciates over time. With commercial real estate, however, they'll be looking at future profits. This means that they will be concerned less with the current worth, and more with the possible worth.
What Are The Types Of Bank Accounts? (12)
A money market account pays higher interest on your deposits than a savings account but there are added restrictions as well. Often, these accounts will have a minimum balance that must be kept in order to earn the higher interest rate.
Residential Investment Property Tips You Can Use! (13)
There's only so much land in the world, and everybody needs somewhere to live! This is an investment that carries a low risk, not like investing in commercial property where you have to worry about the business doing well or badly.
Real Estate 101: Your First Meeting With Your Agent (14)
These questions include: - How long have you been in this business? - What is your list-price-to-sales-price ratio? - What is your marketing plan? - Who are your references?
Commercial Real Estate Financing Lenders And Considerations (15)
Obtaining commercial real estate financing can be a difficult task for even the well-prepared. Before you approach a lender about financial backing, there are certain things you should know about your venture as well as loan criteria.
Profiting From Foreclosure Flipping (16)
If you can buy out their mortgages and release them from the financial bind they have created, they are often willing to give you a good deal on the home.
Should I Attend Property Investment Courses? (17)
Its the advanced techniques used by successful property investors that will set you apart from all those other wannabe property investors. - How many people will be attending the course?
Knowledge Is Key To Make An Effective Auto Insurance Comparison (18)
A person having his or her car towed is one example of this type of coverage. Medical Coverage Required and optional medical coverage varies greatly from state to state.
Real Estate Investing 101: Purchasing Rentable Properties (19)
Therefore, you should select real estate that is in an area where people want to live. In order to determine if the property is in a good area, consider the available shopping and activities that are near to the property.
1 Simple Tip To Save More Car Insurance (20)
For your information, drivers aged under 50 are 31% more likely to make a claim on their vehicle insurance than those aged. In conclusion. It is important and crucial to compare different insurance quotes and see which insurers can help you.