Perhaps it’s time for you to retire. You’ve worked hard all your life, and you’re looking forward to selling your business and getting a place on the beach in Florida. On the other hand, maybe you’re somewhat in the hole with your business, and you don’t know what else to do, but cash out now before you get any deeper. Either way, selling your company is the choice you’re going to make, but have you thought about how taxes are going to play into all of this?
Personal Income vs. Capital Gains
The profits from selling a business are regarded as “income,” and there are two main ways that it can be taxed: as personal income or capital gains. Legislation determines the rate and classification of personal income vs. capital gains, which is constantly chaning. As a rule of thumb though, personal income is taxed about 10 percent higher than capital gains. So, the advantages of capital gains are obviously greater than that of personal income. The income that you will claim will depend on how your business is structured and how you divest yourself of ownership.
What Type of Business Do You Have?
Determining exactly how you will be taxed is largely due to how your business was set up when you first started it.
sole proprietorship – The business is owned and operated by one individual and there is no legal distinction between the business and the owner. If you are a sole proprietor you must pay capital gains taxes on any property sold, as well as personal income taxes on assets.
partnership – The liabilities are split between two or more owners, pursuant to a contract. Like a sole proprietor, partners must also pay capital gains taxes on property, as well as income taxes on inventory, equipment, etc.
limited partners – With a limited partnership, one party is required to assume the role of a “general partner.”
corporations – An establishment that is granted a charter recognizing it as a separate legal entity having its own liabilities and privileges, distinct from those of its members. For corporations, the sale of stocks has to be accounted for. Selling a corporation has its advantages because when stock is transferred, the liabilities are as well. With a corporation, you have the choice of selling either the stock of the company, or its assets. If you sell the assets, the shareholders will be liable for personal income taxes from the sale, similar to selling a sole proprietorship or partnership.
S-Corporation – You can sell either assets or stock, as income here flows directly into stockholders’ personal income. Stock and asset sales each yield similar taxation.
C-Corporation– Here, you’ll probably be selling stocks, not assets. If you were to sell the corporation’s assets, the corporation would have to pay tax on the sale, and you would personally have to pay tax a second time on the after-tax amount you take from the corporation.