Reduce Capital Gains Tax in the Sale of a Business

Hopefully, before selling a business, you meet with a CPA or tax accountant and get an estimate on how much of your proceeds will be going directly to Uncle Sam if you pay them in a lump sum at time of sale. You don't want to save this surprise for after all is said and done, because not only will it most likely be a shock, but you will have given up your chance to do anything about it.

Planning is everything. For this article I will assume you are not doing a 1031 business exchange, that is selling your business and buying another similar business taking into consideration all the IRS guidelines and timelines. It's pretty rare to see this, but it can defer all of your capital gains tax if done correctly. A 1031 Exchange is more commonly implemented with real estate.

Depending on how the business is sold, the gains may be taxed as long term capital gain, short term capital gain, ordinary income, etc. and if you are selling an asset in a C-Corp you may face double taxation. So, the idea is to minimize your tax bill and maximize your proceeds no matter what situation you are in.

One option is with a Self Directed Installment Sale. The structure must be in place before the buy/sell agreement is signed. The gist is to receive the sale proceeds in installments and only pay capital gains tax as you receive the income. This has the effect of allowing the majority of money you would have paid immediately in taxes to continue earning compounded interest for you for many years, thus increasing your bottom line by a significant amount.

The details are a bit too complex to fully outline in a short article, but both an LLC and a Trust are created for you and set up meet IRS criteria for favorable taxation of installment sales. Your asset gets transferred to the LLC prior to sale, and your buyer purchases from your LLC. The trust buys the shares of your LLC from you via an installment agreement and you pay taxes on your gain only as you receive the payments.

You, the seller, are able to control when the payments begin and how long they will be spread out. This allows for maximum flexibility to control your income, and plan for future tax savings as well. Since your buyer paid cash in exchange for your property, you are not dependent on them to make the installment payments and you have transferred the risk of refinance or default. This is done by using an independent third party administrator and your money is safely invested in a principle protected insurance product to be used solely for the purpose of paying the installments.

If you pass on before receiving all of the payments due, the remainder of the installment payments pass to the beneficiaries of your choice.

Seeing an example of a taxed sale vs. a Self Directed Installment Sale side by side will show you how much of a difference in overall return this strategy will provide. This can make the process of the sale more palatable and provide a dependable income stream for retirement.

The tax benefit of this approach is similar to your 401K or IRA account. You reduce your current income by the amount of your annual contribution and thus defer the tax you would have paid on that income amount. Those funds are invested in stocks and bonds and grow in value, sometimes dramatically, for the period before you retire and start taking distributions. When you start distributions, the amount is treated as ordinary income and you are taxed at your much lower (you are no longer working and earning a big salary) income tax rate at the time.

The Self Directed Installment Sale allows you to similarly defer your capital gains tax from the sale of your business. Instead of paying all of your capital gains at time of sale, you set up your SDIS to pay out your sale proceeds over time. If you pay all of your capital gains tax at time of sale, that money is gone forever. However, with this vehicle, you spread your receipt of the sales proceeds out over, 15 years for example. When you receive your distribution, you are then taxed for the portion of that distribution that is attributed to the capital gains - generally about 15%.

The difference in after tax proceeds are dramatic and are demonstrated by a complex analysis called an illustration. I will try in an abbreviated fashion, however, to demonstrate the potential impact. If you sold your business and you had a capital gain of $3.46 million, your lump sum capital gains tax payment at a 15% rate would be $519,000. In the SDIS you would keep the entire sale proceeds of $3.46 million and take distributions over a 20 year period or whatever period you chose. You receive an annual payment over 20 years, that would consist of 1/20 of the principal, 1/20 of the capital gains, plus investment returns.

If we did an illustration of this case and compared selling the business and paying all the capital gains up front and invested the remaining proceeds in a 6.85% compound growth portfolio versus the SDIS paying 1/20 of the capital gains annually, you would gain an $831,000 advantage in after tax proceeds. Not to bad for a little advanced planning.

Florida Property Taxes - Reduce Them, Or Your Capital Gains Tax, With These Strategies

If you decide to relocate to Florida, you'll have property taxes just as in any other state. The good news is that Florida property taxes are very reasonable. The median home value in Florida is $189,500. The average property tax is $1,495, which means Florida has the 22nd highest average tax amount in a comparison of all 50 states. As a percentage of a home's value, Florida property taxes are approximately .79% of the home's value (28th highest out of 50).

Florida property taxes as a percentage of a person's income are slightly higher, measuring an average of 2.95% and putting Florida at the 19th highest position in this measurement. So from these statistics, you will likely find that the dollar amount of your Florida property taxes and the percentage of your home's value that the taxes represent will be similar to or lower than what you pay now. However, if you were earning a salary in Florida, you'd find your property taxes might represent a higher percentage of your annual income than you were paying in your old state.

However, there are two strategies you can use to reduce the amount of tax that you will have to pay. One will reduce your annual property tax, and one will allow you to reduce the tax you will pay on the sale of your home. Unfortunately, only one or the other will apply at the same time.

First, there is the Florida homestead exemption that is applied to a home that is your permanent and full-time residence. In other words, it's not just your vacation home.

If you do have a vacation home in Florida, you will have to pay full Florida property taxes. However, there has been an interesting change in the IRS laws regarding 1031 exchanges, more commonly referred to as the 'swapping' of investment property. Under the IRS laws, an investment or business property can be sold and the proceeds will be tax-free if they are reinvested in a 'like-kind' property. However, this meant that homeowners were not allowed to use their own property as a vacation home without risking that it would be considered 'mixed-use' (taxable) rather than an investment property.

With the changes in the law, there is now a 'safe harbor' for these sales that so that you can enjoy your vacation home in Florida and eventually sell it at a higher value, then roll the proceeds into another home in a tax-deferred sale. The advantage is two-fold; you get to rent the home for the majority of the year, earning income to pay the mortgage. And you get to enjoy the home yourself without losing your earnings to taxation at the time of sale. In order to avoid taxation on the gains as personal income, you need to do the following:

· Purchase the home and keep it for a minimum of 24 months
· For each of the 12 month periods you own it, you must rent it out for at least 14 days of the year at market value
· Stay in it yourself no more than 14 days or 10% of the time you rented it out, whichever is greater.

Remember to always consult your accountant or tax attorney before making a 1031 exchange. The rules can change quickly, and you don't want to act under a false assumption.

Selling Your Business - A Tool To Reduce Capital Gains Taxes

"I would rather expire at my desk than to sell my business and pay Uncle Sam one dime in taxes." How many owners that have paid their fair share of taxes for twenty years of building their business feel this way? The tax bite is the single biggest factor in an owner's reluctance to sell his/her company.

I have previously written articles discussing various aspects of transaction structures to minimize taxes. As a result, I am often contacted by a panicked seller that is a week from closing his business sale as he looks in disbelief at his accountant's spreadsheet detailing the tax burden of his impending sale.

Recently, the seller of a Sub Chapter S Corporation with an $8 million transaction value contacted me. The tax basis was below $200,000 and $4 million of the transaction value was the assumption of debt. When the dust settled, he was looking at a capital gains tax liability of a staggering $965,000 while only receiving the remainder of proceeds after the assumption of debt. The assumption of debt is considered as part of the capital gain for tax purposes.

The owner sent his accountant's spreadsheet to me and since I am not a tax accountant, I sent it to my tax wizard at BDO Seidman. He found a few small tweaks, but said that there was not much that could be done from an accounting standpoint for this owner. When I reported this back to the seller I could feel his disappointment and frustration.

So I began my quest for a better solution. After several dozen phone calls to my professional network, I was directed to a little known vehicle called a Private Annuity Trust. This vehicle has passed the scrutiny of the IRS and the Tax Court. It is not a way to avoid the payment of taxes, rather a method of deferring them with substantial economic benefit to the owner's beneficiaries.

Below is a simplified description of the process. As the owner contemplates the sale of his business (or any highly appreciated asset for that matter) he "sells" it to a trust PRIOR to its ultimate sale. This trust purchases the asset at FMV and exchanges an annuity payment stream complete with IRS life expectancy tables and interest rates. The trust then sells the company to the buyer to fund the annuity.

The transaction is accompanied by a gift to the trust in the amount of 7% of the face value of the annuity. This is so it qualifies as a trust by creating an entity with economic value. Remember, the private annuity is viewed as having zero economic value because the asset minus the obligation theoretically equals zero.

The trust is in the name of the owner's beneficiaries and all aspects of the trust are controlled by the trustees/beneficiaries and not by the owner. The trust for the benefit of the heirs owns the assets and owns the annuity payment obligation. The trust can be structured to defer the annuity payments for a period of time to coincide with the owner's need to receive these payments, lets say, for example, ten years During those ten years the trust's investments or a commercial annuity grow without incurring a tax bite for the business sale.

When the annuity payments start, the owner is taxed at his then current tax rate for the portion of the annuity payment attributable to the capital gains, his basis (no tax), and depreciation recapture from the sale, and the income produced from the annuity. The annuity pays the owner and spouse this annuity payment until last to die or until the annuity investments run out. If the owner and spouse die, any remaining assets are transferred to the beneficiaries outside of estate tax liability.

If your investments perform at the rate used in the annuity calculation and the last to die lives to their exact life expectancy, theoretically the trust value will be whatever the gift portion (7% of the selling price) has grown to. However, if the investments do very well and you outlive the life expectancy tables, you could receive payments well in excess of the original annuity face value. Those excess payments would be taxed at your then current income tax rate.

If the investments do well and the value grows above the required annuity reserve amount, the excess can be distributed to the beneficiaries as income.

In the simplest of views, this acts like an IRA. You are not currently taxed on the amount you put in, it grows tax deferred and you pay taxes upon distribution, hopefully at a far more favorable tax rate. In the case of the frustrated seller from above, what if he deferred all payments by ten years on the full sale price and the $965,000 in capital gain taxes owed? He had a life expectancy of 20 years beyond the start of the distributions. The $965,000 that he did not pay in taxes grows at 7% to $1,939,323 by the time distributions start.

Every annuity payment contains a portion of the capital gain or 1/20th of the total capital gain annually. Therefore, the bulk of the resulting investment value of the capital gains tax deferral provides huge returns for years to come.

If it seems too good to be true, remember it is tax deferral and not tax avoidance. The owner has sold his business first to the trust in return for an annuity payment stream. The owner cannot control the trust. To the extent that the owner wants immediate access to some of the sales proceeds, he would pay all taxes in proportion to the amount he is receiving. In cases like the one above, this tax deferral tool can have a dramatic impact on the financial status of the owner and his heirs by allowing the tax deferred funds to compound for many years before their ultimate distribution and the payment of any tax.