Selling a family business is a significant process that is impactful in numerous ways.
Selling a family business is a significant process that is impactful in numerous ways. It can represent the start of a well-deserved retirement and the culmination of years of work. 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 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 doesn’t 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 doctrine.”
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 that will I stay in the family. Ideally, exploring and evaluating different alternatives in selling a business might take several years.
We can help you consider your family and business’ options and needs, then develop a comprehensive plan fit for you. Contact us today to get started.
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.