If you decide to sell your business, or part of it, at a profit, there are going to be tax consequences. The challenge is to determine the total tax cost on the profit you expect to reap. New law changes impact what you'll net from the sale, and can influence how you structure the deal.
Capital gains rates
If you are in the 39.6% tax bracket in 2013, 20% of your profits will be taxed as capital gains. You're in this top tax bracket if your taxable income exceeds:
- $400,000 if single
- $425,000 if head of household
- $450,000 if married filing jointly or a surviving spouse
- $225,000 if married filing separately
Depending upon the situation, you may want to structure the sale as an installment sale so that you'll receive payments over time. This may enable you to pay less taxes overall. Instead of recognizing all of the gain in the year of sale, you pick up only a portion of each payment as gain, so you effectively spread your tax payments over the installment period (which can be 5 years, 10 years, or any other period you and the buyer agree to). The capital gain rate you pay on each installment depends on the tax bracket you're in at that time. If you are in a tax bracket higher than 15% but lower than 39.6% when you receive installments, your capital gain rate will be 15% (even if you would have paid 20% in the year of the sale). Note: Interest on each installment payment is taxed as ordinary income.
Starting in 2013, there is a 3.8% additional Medicare tax on net investment income. Called the net investment income (NII) tax, it applies to the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over a threshold amount. The threshold amount is:
- $200,000 if single (including head of household)
- $250,000 if married filing jointly or a surviving spouse
- $125,000 if married filing separately
Is gain from the sale of a business considered "investment income" for purposes of the NII tax? It depends.
- Sales of sole proprietorships. Gains from the sale of assets in your business are not treated as investment income. Of course, the gain does increase your MAGI, which can have the effect of triggering or increasing the NII tax on your other investment income.
- Sales of interests in partnerships, limited liability companies (LLCs), and S corporations. Gains are treated as investment income only if you are a passive owner. As long as you have been an active owner, then gain is not treated as investment income for purposes of the NII tax. Again, even if the gain itself is not investment income, it does impact the NII tax on other investment income.
- Sales of shares in C corporations. Whether or not you actively participate in your company, gain on the sale of your interest is treated as investment income.
Find more information about the NII tax from the IRS.
If you are in a state that has its own income taxes, don't overlook the tax owed to your state. Only a handful of states have no state income tax, but many that do levy only modest rates.
If you anticipate a sale in the near future, it may save you considerable state tax dollars to relocate now. Weigh personal considerations against potential tax savings in deciding whether to move to a tax-friendly state. Make sure the move is done a sufficient amount of time prior to the sale in order to obtain the desired tax results. Find the most tax friendly states from the Small Business & Entrepreneurship Council's 2013 Business Tax Index.
Putting it altogether
You may not have as much in your pocket after the sale of your business as you think. Work with your CPA or other tax advisor to craft the best sale arrangement possible to meet your personal and tax needs.