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Regardless of your motivations, selling a business can be a highly stressful process. The last thing you want is to lose a significant chunk of the sales price to government legislative requirements such as Capital Gains Tax.
Landing a large sales price on your business is exciting but sadly, large payout often means large tax bill. In this article, we’ll take you through Capital Gains Tax and suggest one of the most popular methods of reducing it – an installment sale agreement.
What is Capital Gains Tax?
As the name suggests, Capital Gains Tax is a tax levied on any large sale, such as that of a property or in this case, your business. Capital Gains Tax exists to encourage long-term investment, so if you’ve only held the company for a year and think it’s time to sell, you’ll have to pay an increased rate.
Although the rates you pay are dependent on your tax bracket and how long you’ve owned the business, you’re still going to land a hefty bill that will take a bite out of your lump sum profit.
Installment Sale Agreements are your solution
Considering the steep tax rates that the IRS has set, it’s easy to see why some look for ways to avoid them. For business sales, the use of an Installment Sale Agreement can help to significantly reduce the tax you pay. For this reason, it’s becoming an increasingly popular option.
An Installment Sale Agreement is a method through which investors can defer a certain amount of capital gain to future tax years. If a chunk of your profit is due to push you over your tax bracket threshold, an Installment Sale Agreement could help to avoid this.
How can Installment Sale Agreements help with Capital Gains Tax?
The concept of an Installment Sale Agreement is relatively simple to execute. As opposed to one lump sum, with an Installment Sale Agreement, the buyer pays the sale price off annually. This includes any interest that may be applicable.
For example, if you bought your business for $400,000 and sell it for $1 million, you’ve made a gain of $600,000. Instead of receiving the full amount, you can reduce the capital gains tax implications by setting up annual installments of $100,000, to be paid over a term of 6 years. The flexibility of Installment Sale Agreements is a huge benefit, as it allows you to adjust your annual income to suit your financial requirements.
Reduce the tax on short and long-term business investments
As it’s designed to encourage long-term investment, capital gains are taxed differently depending on how long you’ve held your business for.
If you’ve bought then sold within the space of a year, your $600,000 would be taxed at a higher rate, as if it were a short-term investment. If you’ve held your business for 5 years, however, your gains would be classed as the product of a long-term investment and taxed at a reduced rate.
Short-term gains are taxed at the upper-end of your income rate, but both investment types still receive a hefty tax bill. Using an Installment Sale Agreement can be an effective method of reducing tax on both short and long-term gains. If your sale was in excess of $5 million dollars, you can even accrue compounded interest.
Seek help from financial and legal professionals
If you’re interested in setting up an Installment Sale Agreement, you should always work with a reputable Tax Advisor. This is because, although relatively simple to set up, there are strenuous rules and regulations surrounding Installment Sale Agreements.
Business owners who understand and follow the processes, however, can retain many tax deductions and capital gain benefits that would otherwise have to be forfeited.
You should also be careful to account for scenarios where the buyer could manipulate the contract agreement. For example, if they were to sell the business to another individual prior to making full repayment, this could affect your gains. Ensure all loopholes are covered in your contract by seeking legal advice prior to moving forward with a sale.
For more information on Installment Sale Agreements or to discuss your financial requirements further, get in touch with us today. One of our experienced advisers will be happy to help.
He has accrued broad financial experience working with companies ranging in revenues from $50,000 to $60 billion.Dan has worked with technology services, software, real estate, retail, manufacturing companies, professional services firms, marketing/advertising agencies, dental practices, medical practices, and various other industries, providing each with the specific financial guidance needed to establish sustained business growth and financial health.