Tax Strategies for the Sale of a Privately-held Company

Tax Reform? Hardly. Alternative minimum tax (28%), California State income tax (9.3%), and recapture of depreciation (25-28%), loss of other exemption and deductions, can add up to an effective tax rate of 35-40%. If you liquidate, then sell the assets, the proceeds are taxed twice.

Sell the Stock or Assets?

A seller prefers to sell stock, because the proceeds are taxed only once. A buyer prefers to buy assets, and receive a step-up in basis.

A Tax-Free Exchange of Stock or Assets has many IRS complications and qualifications. But under the appropriate conditions, a seller can exchange stock or assets with an acquiring company tax-free at the seller’s carryover basis.

• At least 90% of all assets, or 80% voting stock, must be sold to acquiring company.
• Sale must be made solely for voting stock of buyer.
• If stock of buyer is publicly held, exchange is almost as favorable as cash.

An Installment Sale is often used when seller-financing becomes a necessary part of the package. An installment sale spreads out the realization of capital gains over the installment payment period.

• Depending on seller’s financial status, may or may not decrease taxes ultimately paid.
• Retain business risk during installment payments.
• Defers capital gains tax only until next installment payment.

A Private Annuity is rarely used. It is similar to an installment sale, except that all payments cease upon seller’s death. Technique can have estate planning consequences.

Employee Stock Ownership Plans (ESOPs) are used by a majority owner to create a ready market for company shares. Under this approach, the company can make tax-deductible cash contributions to the ESOP to buy out an owner’s shares, or the ESOP can borrow money to buy the shares.

• Expensive to establish, administer.
• Owner can diversify, yet still maintain control.
• Once ESOP owns 30% of all shares, owner can reinvest proceeds, defer tax on capital gain.

Early planning is critical. IRS has strict rules and time limits.

Know your options before you list your company.

A Charitable Remainder Trust is often dismissed and commonly misunderstood because of the charitable notion.  It is a technique that both avoids capital gains tax and continued business risk, and offers the opportunity to truly cash out without paying taxes on the sale of the business.

• Lifetime income stream.
• Capital gains and state taxes avoided on the sale of the business.
• Sales proceeds are held in a tax-exempt trust, and can be invested and compound tax-free, similar to an IRA.
• Future charitable gift yields sizable tax deduction today.
• Turn an illiquid business investment into a diversified portfolio.
• No business risk.
• Income stream and tax deduction can be highly customized.
• Remove all asset appreciation from your estate.