5 Tips on Tax Planning for Your Exit Strategy

Although it may seem counterintuitive, creating an exit strategy may actually be one of the most important components of your business plan. This is because the sale or transfer of a business typically involves many people and will often trigger one or more taxable events. Let’s take a look at some business tax planning strategies that you might be able to use to prepare yourself for the day that you no longer run your business.

Your company’s structure will play a significant role in how you decide to exit your company. If you are a sole proprietor, you will pay taxes on any profits that you make during the course of a year. For instance, if you made $100,000 in profit from the sale of company assets, you’ll need to pay ordinary income or capital gains taxes on $100,000.

If your business is structured as a partnership, you will pay income or capital gains taxes on any profits realized at the time of the sale. In the event that you sell an ownership stake in a traditional corporation, you may be required to pay taxes at both the corporate and personal level. However, corporate taxes may not apply if you sell an ownership stake in an S corporation.

A buy-sell agreement may be beneficial if you own the company with one or more partners as part of your exit strategy. First, it stipulates how much your shares are worth in the event that you want to sell your stake in the business. It also stipulates who can buy your shares and how the transaction will be funded. It’s not uncommon for purchases made under this type of agreement to be funded by a life insurance policy.

This can be ideal because any funds that you receive from such a policy are generally obtained tax-free. You may want to have a buy-sell agreement or any other agreement drafted or reviewed by an attorney.

Doing so may reduce the risk of a dispute that cannot be resolved outside of court. If you are subject to a lawsuit regarding a buy-sell agreement or any other document, you’re encouraged to hire a business litigation Carmel professional.

Your cost basis will determine whether you actually make a profit or loss from the sale of your business. Let’s say that an appraisal of your company reveals that it’s worth $1 million. However, let’s say that you have spent $500,000 on supplies, equipment and other expenses throughout your time as owner. In such a scenario, your cost basis would be $500,000, and if you sold the company for $1 million, you would owe capital gains taxes on $500,000.

Understanding cost basis is important if you decide to engage in an asset sale as opposed to a stock sale. For instance, say you bought a tractor for $10,000 five years ago. As part of the sale of your company, you sold that tractor for $5,000. Ultimately, you would incur a capital loss of $5,000 on the sale, which could be used to offset any gains made in other transactions.

While planning your exit strategy, it’s important to consider that tangible assets such as tractors, cars or office furniture may depreciate in value over time. If you claim the depreciation on a tax return, it may also have an impact on your cost basis on a given item. Hiring a professional accounting and tax services company may be able to help you determine if you need to claim a capital gain or loss after selling something the company owned for several years.

Typically, a company will be sold as a complete package. In other words, the sale price will include both majority ownership of a company’s outstanding shares as well as the value of its assets. It’s worth noting that assets may include the value of intangible assets such as brand reach or goodwill that a brand has accrued since it began operating.

Selling assets separately may be an ideal exit strategy if you operate your company as a sole proprietor. This can help to ensure that you have a regular income over the course of many months or years, and it can also help to spread the income or capital gains tax hit over a longer period of time. It can also be ideal if your business owns land, buildings or other property that may increase in value while still in your possession.

If you are planning to transfer ownership of your business to family members or other key employees, you may want to do so in a gradual fashion. The IRS allows you to gift up to $16,000 per year to as many individuals as you would like. Making gifts to your employees or family members enables them to take control of the company at a controlled rate while also reducing the value of your holdings for tax purposes.

Of course, if you are planning to keep the company until your death, it may be best to make gifts in a strategic fashion as beneficiaries may get a step-up in cost basis. What this means is that whoever inherits an asset after you pass may get to avoid paying capital gains taxes on the difference between what it was worth when you purchased it and what it’s worth today.

The time to prepare for the tax implications of exiting your company is long before you actually do so. Working with a financial adviser may make it easier to understand how concepts like the structure of your business can impact your current and future tax situation. Feel free to contact an adviser from Savage Accountancy today who may help with succession planning or other important exit planning tax issues.