How to avoid capital gains tax on a business sale

Summary 

Do you have to pay capital gains tax on the sale of a business? 

Capital gains tax is the tax you pay on the interest or profit of an investment or asset that you sell. You’ll pay capital gains tax on physical items and intangible assets, which means that the IRS typically expects capital gains tax on the sale of a business, too.  

Paying capital gains tax on a business sale is generally unavoidable. However, there are strategies you can use to reduce the amount of money owed.  

Planning is one of the most important things you can do to reduce capital gains tax on the sale of a business, especially if you are in the early phases of a potential sale.  

How is the sale of a business taxed? 

According to the IRS, the sale of a business must be subject to capital gains tax.  

Capital gains tax is any tax that is assessed after selling an asset for more than what you paid for it. That asset is placed in either the short-term or long-term capital gains category and is appropriately taxed from there.  

Short-term capital gains tax is typically charged higher, going up to as much as 37%, while long-term capital gains tax tends to be lower, between 0 and 15%.  

When it comes to capital gains tax on a business sale, the rate is levied based on the venture’s profitability. The more profitable the business, the higher the tax rate would be.  

Tax rate variations also depend on the business's structure, such as whether it is a sole proprietorship, partnership, or corporation.  

If a business is a corporation, it will be taxed at corporate tax rates; however, if it is owed by a single entity (e.g., a sole proprietorship), the tax rate is lower. This means that the capital gains tax on a small business sale will be less than the tax on the sale of a corporation, even if the profitability is equal or higher. 

How do you time your sale to reduce tax liability? 

Timing can help reduce capital gains tax on the sale of the business.  

Short-term capital gains tax rates are much higher on average than long-term rates, meaning that holding on to your business for longer than originally intended can result in a lighter tax burden.  

When choosing the right time to sell, consider market conditions and any tax implications you may already be aware of in your business and financial affairs.  

How to avoid capital gains tax on a business sale 

There are a number of strategies to prevent or offset capital gains tax.  

Talking to a financial advisor and efficient tax planning are two of the most effective strategies for minimizing your capital gains tax on a business sale, but some other options include: 

Installment sales involve selling your business in parts rather than as a whole. The phased-out payments result in a lower capital gains tax rate, allowing you to reduce your overall tax burden.

Negotiation plays a big role in determining how much your capital gains tax on a business sale will be. This is due to the allocation of the purchase price.  

The IRS stipulates that the majority of the price should go to capital assets rather than depreciating ones, so make sure you negotiate the asset values carefully so that you receive the most favorable allocation possible.  

If you own a corporation, capital tax gains can be significantly minimized by selling stock to current employees.  

This is known as an employee stock ownership plan (ESOP). The advantages of setting up an ESOP are that you don’t have to hunt for a buyer, and the cash you earn from the business sale can be incorporated into an investment plan to decrease capital gains tax.  

Another way to defer capital gains tax on a business sale is to reinvest capital gains into an Opportunity Zone. This strategy involves reinvesting capital gains within 180 days of the sale to qualify for a tax break.  

Get expert financial advice 

If you are selling your business, capital gains tax is largely unavoidable. However, you can offset your capital gains tax on a business sale through effective tax planning, picking the right time to sell, setting up an ESOP or opting for an installment sale.  

If you’re trying to avoid capital gains tax on a business sale, it’s also always advisable to seek the help of an expert financial advisor. Unbiased will match you with an SEC-regulated advisor who will help you maximize your profits and minimize your tax obligations.