The sale of a business usually creates a sudden cash windfall that can create a substantial tax liability if the transaction isn't executed strategically. If you will soon sell a business, here are some strategies that you can use to minimize your tax liability on the sale.
Postpone the Sale for One Year
If you've owned a business for less than one full year, try to wait until the one-year mark before you sell your business. This is perhaps the single most effective way to reduce your tax liability because it directly impacts how proceeds from the sale of your business are taxed.
Any proceeds that you earn from the sale of a business are considered capital gains. They'll be taxed as short-term capital gains if you've owned the business for less than one year, and long-term capital gains if you've had the business for more than one year. The tax rate between the two is substantial.
Short-term capital gains are taxed as regular income -- which means you could end up paying as much as 37 percent on the sale of your business if you sell in 2020. This is the highest income tax bracket for the year.
In contrast, long-term capital gains top out at 20 percent in 2020. Even if you aren't in the highest brackets, the differences in lower brackets are still notable. Long-term capital gains are taxed at 0 percent on up to $40,000 in 2020, while short-term capital gains are taxed at a minimum tax rate of 10 percent and go up from there.
Create an Installment Agreement
If the sale price of your business will put you into one of the higher long-term capital gains tax rates, you can keep your taxes lower by spreading the sale out over a few years. For example, you might spread a sale out over three years so that your capital gains in any one year remain lower.
Buyers are usually also in favor of installment agreements since an agreement lets a buyer spread out payment over several years rather than making it all at once.
Invest in Another Business
Should you quickly roll over the proceeds from one business into another business, you might not have to claim any gains from the sale. The money won't qualify as capital gains -- and won't be taxed -- if it's used to pay for legitimate expenses related to another business.
To learn more about selling businesses, how to avoid taxes, and more, consult a resource in your area.