Is an installment sale right for you?
Another option which could be beneficial is an installment sale. Ultimately, this can allow you to pay taxes over time, instead of all at once.
For example, you could take back a mortgage or note for a portion of the purchase price and report your capital gains through the installment method. Once the sale is complete, you can then defer the total tax due until you receive payment over the years.
All it takes is the receipt of one payment after the year of your sale to constitute an installment sale. It cannot be utilized if your sale ends up as a loss, however.
Also, the majority of your business assets won’t be eligible for the installment sale method— at least in most cases.
Why? Because only assets which receive capital gains treatment are eligible for installment sales. This means, in turn, that any assets which fall under ordinary income cannot be used as part of installment sale. Importantly, this includes payments for the following:
- accounts receivable
- property used for no more than one year
- personal property when depreciation has to be recaptured
For the items listed above, you will have to pay tax on any gains during the year of the sale, regardless of whether or not you’ve received payment for those items.
Using the installment method when selling your business
To use the installment method, you will have to make a few calculations.
First, you need to know your allocation of the total purchase price distributed among all the assets you’ve sold as part of the sale.
After that, for every asset you want to use an installment method on, you need to compute a gross profit percentage.
You can calculate your gross profit percentage by taking your asset’s gross profit and dividing by its selling price.
Gross Profit / Selling Price = Gross Profit Percentage
If you first need to calculate your gross profit, you can do this taking an asset’s selling price minus interest, and subtracting the adjusted basis of the property, selling expenses, and any depreciation recapture.
(Selling Price – Interest) – (Adjusted Basis of Property + Selling Expenses + Depreciation Recapture) = Gross Profit
Now, every time you receive a payment, the principal portion of that payment (everything except interest) is multiplied by the gross profit percentage. This final figure will be the amount that you must report as taxable gain during that year.
Should a buyer assume any debt as part of your final deal, the assumption will be treated as a payment to you, in regard to the installment sale rules. If some of the purchase price is placed in an escrow account by the buyer, this will not be considered a payment until you have access to those funds (i.e. until they’re released to you).
If you and your buyer have opted for an earnout provision, certain rules apply. In this case, it is highly recommended to consult a tax professional for further guidance.
How do I sell a corporation: asset sale or stock sale?
When it comes to selling a corporation, you have two options: sell the stock in your corporation or sell all of its assets.
Due to tax considerations, C corporation sellers will almost always want a stock sale, while buyers will prefer an asset sale.
Here’s why: with an asset sale, a seller will have to pay taxes twice. First, they will have to pay taxes on all gains from the sale of assets. After that, shareholders will also have to pay capital gains tax once the corporation is liquidated.
On the contrary, if you negotiate a stock sale, you can expect to pay capital gains on all profit from the sale. Usually, this is at a long-term capital gains rate. Of course, from your perspective, paying taxes once— and at a long-term capital gains rate— is much more advantageous than paying taxes twice.
For the buyer though, things are different. Most buyers will prefer an asset sale. In such a case, the buyer’s basis for depreciation will be the allocated purchase price of transferred assets. This differs in a stock sale, where the basis of stock shares are stepped up to the purchase price of the stock. In this case, the buyer takes over whatever basis the seller had in assets. And, if the seller already depreciated some of those assets down to zero, the buyer can’t claim any depreciation deductions on them. In the end, buyers will generally prefer asset sales.
Another important note: when comparing the two, the lowest overall amount of taxes to be paid— when both the buyer’s and seller’s taxes are combined— is usually a stock sale.
One way a seller can leverage this potential advantage is by adjusting the purchase price to account for any future tax burdens faced by the buyer. In this case— theoretically at least— both parties can walk away at the end of the deal with more cash in their pockets and less going to the IRS.