Small Business Tax Aspects of Selling a Business
© by Fred W. Daily
What tax things should you know when selling the most common form of business
-- a "sole proprietorship?" Your sole proprietorship could be just a one man
show, a mom and pop, or an operation with thousands of employees, but if you are
incorporated, a partnership or limited liability company, then the tax rules are a little
different than covered below.
Congress, realizing that there are opportunities for people to play tax games
on business transfers, has enacted laws to ensure that Uncle Sam gets his cut. So, we
start with the proposition that selling a business or its assets is a taxable event,
meaning that it usually produces a gain or loss to the seller.
From the IRSs point of view, a business is just a collection of assets
typically, things like equipment, inventory and goodwill. The tax code requires
that sellers and buyers assign a specific value to each asset or groups of similar assets
and report this to the IRS. This is very important step in the process, as the gain (or
loss) on the sale of different categories of business assets may be taxed differently.
Whenever you sell a business asset, you might have a taxable gain, and Uncle
Sam wants his share of it. On the other hand, if you have a loss from the sale, there may
be a tax savings for you.
Lets meet Harry, who sells his sole proprietorship business, Bagel World.
Sally pays him $145,000 for lock, stock and bagel maker. They agree that the kitchen
equipment and ovens are worth $130,000, the furniture $2,000, computers and cash registers
$3,000, the store lease $9,000 and the goodwill of the business $1,000.
When Harry sells Bagel World assets, his resulting gain or loss is taxed like
any other business profit or loss. The tax codes special "capital gains"
(and losses) lower tax rates dont apply when the operating assets of a business are
sold. Any gain is taxed at Harrys personal tax rate. Likewise, any loss reduces his
or her total taxable income.
Harry must report the sale of his business by attaching Form 8594, Asset
Acquisition Statement, to his personal income tax return. Sally must file an identical
form with her next tax return, too. While there is no way of knowing whether or not the
IRS will ever audit Harry or Sally, filing Form 8594 does increases their audit risk.
Arm's length deals with strangers are not usually questioned by IRS auditors.
No one is out to do the other party any "tax favors." However, transfers of
businesses between related parties look suspicious to IRS auditors. So, if Harry and Sally
are father and daughter, the IRS may be concerned that Harry is selling "below
market" to Sally, and beating out the tax man. Hence, the tax code imposes a rule
that business transfers must be made for full and valuable consideration, and not have any
element of a gift frequently inherent in family deals.
One tip for Harry: If he's facing a large taxable gain on the sale of the
business, he should consider selling on the installment plan. For example, a sale with 20%
down and the balance paid over five years (with interest, of course), will spread the tax
on the gain over five years.
By: Frederick W. Daily, Tax Attorney,
John Raymond, Bankruptcy Attorney, and
Allan H. Rosenthal, paralegal.
All of the three have offices in San Francisco.
(This article was originally written for tax
practitioners who represent clients before the IRS. But the information
presented here is valuable for all taxpayers.)
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