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“In this world, nothing can be said to be certain except death and taxes”, said Ben Franklin in 1789. Upon the sale of your business, you are probably going to incur long term capital gains taxes.
Long term capital gains taxes are typically lower than income tax rates, and the actual long term capital gains rate is based upon the rate that applies to your income. The long term rate applies to assets that have been held for over one year, which is almost always the case in the sale of a business.
Capital Gain Calculation
The capital gain is calculated by taking the selling price of the business, subtracting disposal costs, and then subtracting your “basis” in the business. How the basis is calculated can actually be complicated, and is beyond the scope of this article. Basically, however, it is the equity portion of the balance sheet. You should be aware that any debt that you have personally guaranteed is included in your basis as the same as if you had made an equity contribution. Additionally, any depreciation that you have taken since you owned the business is now taxable as ordinary income at ordinary income rates, and not at capital gains rates. This is referred to in tax law as the recapture provision.
An important point is that when you sell a business, from a tax point of view, what is good for the buyer is bad for the seller, and vice-a-versa Prior to closing, an allocation will be made between goodwill and fixed assets, with the fixed assets valued at fair market value. Goodwill must be depreciated over 15 years, while fixed assets such as machinery and equipment can be depreciated at a much faster rate, perhaps even five years. The seller is going to prefer that the greatest amount be allocated to goodwill since any value assigned to fixed assets over book value is taxed at ordinary income rates and not at capital gains rates. A buyer, however, is going to want as much as possible allocated to fixed assets since the faster depreciation allows for more immediate tax savings. Remember the time value of money. What is allocated to fixed assets versus goodwill often becomes a negotiating point. Bear in mind that the allocation should be done objectively, and the contract of purchase and sale will often stipulate that the allocation be made without consideration to the tax consequences or benefit to either buyer or seller.
This is a newly edited and republished version of an article written by Brad Palmer. It is included by popular request.
This article is not intended to be a rendering of legal, accounting, tax or other professional advice. Assistance from a competent professional in these specific fields should be sought.
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