Business owners often have one chance to get the sale of their business right. Failure to correctly plan for an exit can mean significant sums of money lost to unnecessary income and estate taxes. That is unfortunate since the business is often a major part of an owner’s net worth and retirement nest egg — every penny counts.
If you are a business owner and want to secure the maximum value for you and your family, then start planning years in advance. Here are three ways to help get the most out of selling your business:
1. Begin with the end in mind.
“Begin with the end in mind” is the second habit of Stephen Covey’s best-selling book The 7 Habits of Highly Effective People. The end in mind can be selling or gifting the company to family members, selling to employees or selling to an outside third party. Selling shares to a partner presents another possibility. Either way, start discussing options and ideas with a qualified accountant, attorney and financial adviser — each can bring expertise on tax, estate planning and other financial considerations.
If it’s a third-party sale, planning should focus on asset protection and tax savings, with the planning ideally occurring long before a transaction. That’s because some strategies may become more limited once an offer is on the table, or some strategies are more advantageous under the current tax law (more on this in the trusts section below).
Start with a comprehensive wealth plan — assess where you are today and might be after the transaction. Consider:
- What are the steps you should take now if you want to sell in a few years?
- Who are the different types of buyers, and what are the considerations in selling to each?
- What are the tax or planning strategies that you should consider prior to engaging in a transaction?
These are some of the questions we use to jump-start a client’s comprehensive wealth plan.
We also run retirement cash flow projections to help the client see how different scenarios might play out, such as an installment sale or outright sale. The projections help the client see the minimum price they need to sell. We also work with the accountant to sketch out ways to reduce the taxes on the sale or minimize estate and gift taxes. I suggest reviewing the tax returns, estate documents, buy-sell agreements and partnership agreements if applicable and consult with the drafting attorney. It’s all hands on deck when it comes to a successful business sale, and coordination between the accountant, tax attorney and financial adviser is imperative.
2. Enlist an aggressive tax-loss harvesting strategy.
The sale of a business can trigger a long-term capital gain, and capital gains tax will apply. That usually means more favorable tax rates than ordinary income tax rates. However, it is still a tax. If you started a business 20 years ago with an investment of $100,000 and sell it today for $10 million, your long-term capital gain is $9.9 million (the selling price minus your cost basis). A federal capital gains tax of 20% would apply, reducing the net proceeds from the sale to just over $8 million.
To help, I recommend business owner clients pursue an aggressive tax-loss harvesting (TLH) strategy with their personal money as soon as possible. Losses aren’t the goal, but they come up when investing in the stock market. Luckily, the IRS allows investors to offset their gains with losses. The IRS allows investors to use $3,000 of losses to offset ordinary income, and any unused losses are carried forward to use in future years.
For our business owner clients, we open a brokerage account with hundreds of individual stocks bought at various times to create more tax lots. We then employ a daily or monthly tax-loss harvesting strategy – selling if a stock drops below a certain threshold and buying a like-kind security to stay invested, but booking the loss from the sale. (Careful to avoid the wash sale rule.) Our clients carry forward those losses on their federal tax return to offset the gain from selling their business in the future (state rules vary). Simple strategy, but I don’t think enough business owners take advantage of this or at least employ it as well as they can.
For a client with an investment in our TLH strategy, we may book 8% of the account value in losses in the first year and 3% to 7% of the account value thereafter (for illustrative purposes; actual results vary for each individual). The graphic below shows that after five years, this client has $300,000 of booked losses to offset a capital gain from selling their business. Not all tax-loss harvesting strategies are created equal, and the cost and complexity of such strategies is a trade-off. I suggest working with a qualified professional who can help you build a portfolio to meet your needs.
Note: Losses from a stock portfolio are used to offset the gain from selling a business. This is an illustrative example; actual results will vary. Please consult with a qualified tax or financial adviser before implementing.
3. Start planning early with trusts.
Trusts are an important part of estate planning and selling a business. Trusts are used for asset protection, estate or income tax planning and can help provide clear instructions for the distribution of an estate or business.
The key is to start planning early. The current income and estate tax laws are set to expire at the end of 2025, and if that happens, the current estate tax exclusion (the amount each U.S. citizen can exclude from federal estate taxes at death) could decrease from the current $12.92 million to $6.2 million, adjusted for inflation.
To take advantage of the currently high estate exemption amount, consider a spousal lifetime access trust (SLAT). The SLAT allows a married individual to remove assets from his or her estate, such as a closely held business, while still benefiting from trust income indirectly through his or her spouse. Assets transferred to a SLAT are excluded from estate tax. By funding a SLAT now, the donor will be able to utilize the current higher exclusion amount.
SLATs are not for everyone. A drawback to a SLAT is the death of the non-donor spouse will mean the donor spouse no longer has access to the trust assets. Another trust option for business owners is a grantor retained annuity trust, or GRAT. A GRAT removes an ownership interest in a business, taking it out of his or her estate if he or she survives the term of the trust. Trusts are complex, involve additional costs, and can have drawbacks — suffice it to say it’s best to talk to a qualified attorney or tax professional before implementing.
Putting it all together
Selling a business is no easy task. But the best financial planning strategies are often the ones done several years in advance. Starting an aggressive tax-loss harvesting strategy early enough is one idea of many to minimize the capital gains tax. Estate and trust planning is especially important given the current tax laws are set to sunset in 2025, and certain trusts may be more beneficial before securing a business valuation to sell.
The best place to start is a comprehensive wealth plan. A plan for your estate, income tax, retirement cash flow, investments and life insurance is a must for every business owner looking to sell.
To learn more about a Comprehensive Wealth Plan to sell your business, please email the author, Michael Aloi, at maloi@sfr1.com.
Investment advisory and financial planning services are offered through Summit Financial LLC, a SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Summit is not responsible for hyperlinks and any external referenced information found in this article.
