When preparing to sell your company, it’s critical to understand the tax implications of the sale. As a broker, I always recommend that an owner discuss their plans with their financial advisor, ideally a couple of years before they list the business for sale.

I spoke with Tom Martin, a certified financial planner at Martin Financial Group with over 36 years of experience. Here’s what I learned from the conversation:

Developing your tax mitigation strategy for income after the sale

Your advisor will help you understand how much you’ll need to fund the retirement you want. They’ll also be able to predict the future value of any other assets you might have. For most business owners, their ideal retirement income would be roughly the equivalent of the salary they’ve drawn from the company over the past few years. Your financial advisor has a formula for projecting that annual number into the total assets you’ll need to retire.

That helps you plan for the income tax implications of selling. But retirement planning for business owners is different than for corporate executives. The  business owner must first navigate the capital gains tax. What is left over from the sale profit  normally gets deposited into a taxable account that incurs taxes every year on the  entire realized return. 

A corporate executive, on the other hand, generally has most of his money in a tax  deferred retirement account where he pays tax on only the amount he takes from the  account. ”It really requires a different mindset,” said Martin.

How capital gains on the sale of a business are taxed

​Capital gains tax has three brackets: 0%, 15%, and 20%. The bracket is determined by  your taxable income, which includes not only the profit from the sale of your business but all of your other income as well. The 0% capital gains bracket applies to married couples with taxable income of under ~$100,000 before the 15% applies. The 20% bracket  applies once taxable income exceeds ~$500,000. (These thresholds are generally cut in half for single filers).

​For example, suppose you sell your business for $1,000,000 and you have no other  income that year, your first ~$100,000 falls in the 0% bracket, the next ~$400,000 falls in  the 15% bracket and the final $500,000 is taxed at the 20% rate. 

On the other hand, suppose you had $500,000 of taxable income in the year you sell; now the entire gain is taxed at 20%. A lot of the planning that Martin does revolves around  reducing taxable income in the year of the business sale. This might include moving  taxable assets (at least temporarily) into tax-deferred accounts, finding deductions, and other tactics.  Ideally, you would want to have some strategy in place a year or two prior to your exit. 

​And, Martin says, there is a huge and often overlooked planning opportunity in recognizing gains over multiple tax years because each new tax year resets the capital gains brackets. Take the same sale we discussed in our last example. If we could recognize only half the gain in the current tax year and the other half in a later tax year, we would get ”two bites of the apple” on the 0% and 15%  brackets. If we could spread the gain over ten years, it’s possible that the entire amount would fall into the 0% rate.

Martin says that there are a couple of ways a seller can defer the receipt of the sale price. One is to hold a seller’s note, which spreads the profit over several years. The risk here is that you become the bank; if the business fails or the buyer defaults on payments, you have limited recourse. Requiring sellers to hold a note is common in business sales, so this is something you should plan on exploring anyway. The upside is that not only will you receive interest on the balance the buyer is paying back over time, but you will have the benefit of multiple ”bites” at the lower rates.

An option most sellers aren’t aware of: the structured sale

A structured sale (or structured installment sale) is a tax-planning arrangement that allows the seller to work with a third-party assignment company (most often an insurance company) to fund the buyer’s payment obligation. Once a cash price is established between the parties, the deal is then restructured as an installment agreement based on interest rates that insurers are typically using in their annuity contracts. The buyer purchases the annuity and transfers the payment obligation.

The structure is designed to allow sellers to spread recognition of gains over time while receiving scheduled payments backed by an assignment company and its funding investments. The seller is locked into the terms of the arrangement, and the value of the annuity or bonds funding the structure also does not appear on the  seller’s balance sheet. 

Any asset that is eligible for installment sale tax treatment is eligible for a structured  installment sale. Some assets, however, are not eligible. Corporate stock, for instance  cannot be sold on installment. So, if you are planning on using this strategy, the deal needs to be structured as an asset sale. 

Martin says that this strategy must be discussed with the buyer well in advance of closing the deal. Generally, Martin recommends the discussion happen around the time the LOI is received, when both buyer and seller are trying to make the deal work. 

It does require changing the terms of the offer and there is really no material benefit to the buyer. The seller might need to make some additional accommodations to the buyer in exchange for his cooperation. 

Secondly, do not assume that your attorney is familiar with structured sales. They probably are familiar with seller financing, but most have no experience in a structured sale. And your attorney should also want to investigate the relevant tax codes. But it might prove to be the right strategy to protect the earnings from your business sale.

Disclaimer: We do not provide specific financial advice and encourage readers to consult with their own qualified financial advisors.