If you are thinking of selling a business, make sure to consider how income taxes are determined as a result of the sale. There are many aspects of the sale to consider, including reviewing any applicable buy/sell agreement and other factors. but when the sale is completed, the classification of the assets sold will affect your personal or business taxes, so it is important to fully understand these matters before entering into the sale.
The sale of a business generally consists of the sale of all the assets owned by the business or all the ownership interests of the business. If a sale of all the assets occurs, the types of assets sold are treated differently in determining whether a gain or loss was generated from the sale of the assets. As such, there are four main types of categories of assets, and each asset must generally be classified under one of these categories at the time of sale:
- Capital assets. The sale of these assets results in capital gain or loss.
- Depreciable property used in the business. If held longer than one year, sale of these assets results in gain or loss from a Section 1231 transaction.
- Real property used in the business. If held longer than one year, sale of these assets also results in gain or loss from a Section 1231 transaction.
- Property held for sale to customers. This includes inventory or stock in trade, and results in ordinary income or loss when sold.
If your business is a partnership. each ownership interest in the partnership or joint venture, when sold, is treated as a capital asset. Corporate liquidations also are classified as a “sale” for the purpose of determining the taxation of the assets distributed to the shareholders upon liquidation.
the type and amount of taxes due as a result of a business sale, the central question becomes whether the sale is regarding the stock, membership interest or partnership interest of the owners or the just the assets of the business. This question applies to all types of businesses, and is really the starting point for a discussion about the income tax effect of the proposed transaction.
If the entity sells its assets, then payment is made to the entity. Depending on the type of business entity. this may result in gains taxed to the entity or the partners. C corporations, LLCs and partnerships will see the taxes incurred differently. For instance, when the entity sells its assets and then distributes the payment, C corporation shareholders pay a double tax, once when the entity itself pays the tax and again when individual shareholders must pay their individual taxes. LLC and partnership members pay only one level of tax, at the time of distribution.
Similarly, there is a single tax level when owners/partners sell their membership interest, partnership interest or stock. The rating of a gain or loss for each asset depends on each individual’s income tax basis in the ownership interest and will generally result in a capital gain.
Regardless of the type of business and the value of its assets, it is crucial to enter business sale negotiations fully cognizant of how the taxation of the sale of all the assets, stock, membership interest or partnership interest will be handled and what tax obligations you will have when the sale is completed. If you have questions about any of these matters, please feel free to give me a call.
John M. Vaughan is a business law specialist. He can be reached at 303-443-8010 or firstname.lastname@example.org.
About the Author: John Vaughan