It may signify the end of one chapter and the beginning of a new one. When a business is sold to a third party, the transition can be challenging for the entire family of the business owner.
If you are a business owner, you may find that you and your family members will shift from a lifestyle that revolves around your business to one that is reliant on your investment. Of course, special challenges can arise when family members are also employees. When a business interest is sold, careful planning can potentially yield tax efficiencies which could change the terms of the sale. These situations tend to be unique in both profound and nuanced ways. The appropriate solution tends to be a carefully tailored approach based on resources and objectives. Under certain circumstances, a multi-step approach can be applied in order to help reduce taxes.
Installment Sales Reporting
One frequent question in the sale of a business is whether the seller will assist the buyer by “taking back some paper.” If properly structured, the seller can elect to report gain using installment sale reporting1 . This basically allows the seller to defer tax by paying capital gains tax only as payments are received. This deferred tax has to be weighed against the risk of being a creditor to the business buyer.
Selling To A Child
One strategy that requires some rather extended planning involves a parent selling to a child and taking back an installment note. The child would have a tax basis equal to the purchase price of the business2.
The tax rules would make the parent pay all of the capital gains tax if the child immediately sells it to a third party3 . If, however, the child owns the business for at least two years, the sale to a third party does not cause the parent to lose the benefit of installment sale reporting4 . So, the child could sell to the third party for full fair market value with presumably little capital gain, as the child’s basis would be the purchase price from the parent. The child could then continue to pay on the note to the parent, allowing the parent to smooth out the total capital gain tax bite. Taxpayers should take care to avoid executing all of this as a predetermined plan to avoid an attack by the IRS under a principle known as the “step transaction doctrine5.”
Consult Your Attorney Or Accountant When Considering Installment Sales
A complicated transaction like the one described should only be undertaken after close consultation with an experienced attorney or accountant. There are plenty of pitfalls that need to be avoided. On the other hand, if properly executed, the parent winds up with both some tax deferral and the peace of mind of knowing that the funds will stay in the family. Ideally, exploring and evaluating different alternatives in selling a business might take several years.
Working With Janney
Depending on your financial needs and personal preferences, you may opt to engage in a brokerage relationship, an advisory relationship or a combination of both. Each time you open an account, we will make recommendations on which type of relationship is in your best interest based on the information you provide when you complete or update your client profile.
When you engage in an advisory relationship, you will pay an asset-based fee which encompasses, among other things, a defined investment strategy, ongoing monitoring, and performance reporting. Your Financial Advisor will serve in a fiduciary capacity for your advisory accounts.
For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on www.janney.com/crs which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.
By establishing a relationship with us, we can build a tailored financial plan and make recommendations about solutions that are aligned with your best interest and unique needs, goals, and preferences.
Contact us today to discuss how we can put a plan in place designed to help you reach your financial goals.
1. IRC Sec 453
4. IRC Sec 453(e)(2)
Janney Montgomery Scott LLC, its affiliates, and its employees are not in the business of providing tax, regulatory, accounting, or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor
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