During the years when you’re launching and running a thriving business, it can be hard to find time to think about much outside the next thing you need to do to keep the enterprise moving forward profitably. Payroll, inventory, revenue, and marketing can easily consume all the time and brain power you have to offer.
But the day will eventually come when it’s time to exit: to hand the business off to a younger family member, a trusted employee, or a qualified outside buyer. For successful owners who have built a strong business and run it for years, that day can come as a bit of a shock. You’re so accustomed to thinking about your life and livelihood in terms of the business that you aren’t really sure what to do, once the sale has closed and you’ve handed the keys and the responsibility to someone else.
But the period after selling your business isn’t the time for indecision. The first 12 months after a major liquidity event are the most important for determining the direction, quality, and level of satisfaction you’ll obtain in your transition from business owner to your post-exit lifestyle. As you conclude the sale and revise your financial and wealth management strategy, two areas may be paramount: tax management and diversification.
How do I minimize taxes on a business sale?
While paying taxes on the profitable sale of a business is pretty much inevitable, there’s no reason to pay more than your fair share. Several strategies exist for effectively managing the tax levy on your sale proceeds.
Business structure
The first consideration is how your business is structured. Pass-through entities (LLCs, S corporations, partnerships, and sole proprietorships) pay no tax on the proceeds of the sale; that responsibility “passes through” to the owner(s). Owners of C corporations, on the other hand, are subject to double taxation: the corporation pays taxes on all income, typically at a flat corporate rate of 21%. Then, owners and other shareholders pay tax on proceeds they receive. Often, when a C corporation is sold, much of these proceeds may consist of capital gains, which are generally taxed at a lower rate than ordinary income.
Structuring the sale
For some business owners, it may make sense to structure the sale transaction in installments, allowing the seller to spread the tax burden of the sale over several years.
Qualified Small Business Stock (QSBS)
If your business is a US C corp with under $50 million in assets and you have held the stock for five or more years, as a non-corporate taxpayer (an individual, a trust, or an estate), you may be able to exclude up to 100% of your capital gains (up to $10 million or 10x your cost basis basis) from federal taxes by claiming the QSBS exemption. Note that some industries (typically legal and healthcare firms, financial services, hospitality, engineering, and a few others) are excluded from access to QSBS, but if your business qualifies, the QSBS exemption can potentially provide major savings on taxes.
Qualified Opportunity Zones (QOZs)
To encourage investment in underserved areas, federal tax law offers certain incentives to persons who invest in qualified opportunity zones: economically distressed census tracts in the United States or its territories. Created under the Tax Cuts and Jobs Act of 2017 (and made permanent under the One Big Beautiful Bill Act), low-income communities are nominated by state governors and certified by the U.S. Department of the Treasury. Investors do not invest directly into the property or business; instead, they roll eligible capital gains into a Qualified Opportunity Fund (QOF)—a specialized partnership or corporation that holds at least 90% of its assets in QOZ property. Investors may be able to temporarily defer tax on prior capital gains reinvested into a QOF.
How do I diversify my wealth after a liquidity event?
Every business owner knows that without risk, there is no reward. In fact, for many business owners, the value of the business makes up a significant portion of their net worth, placing tremendous risk on the ongoing performance of the company. But after the sale, the seller must make a very important decision: how to deploy the windfall from the liquidity event to support their desired lifestyle and also manage risk over the long term.
Proper diversification involves spreading one’s investable assets across a broad array of asset types, thus reducing dependence on the performance of any one asset and also managing market risk. And this is the part of the process where a qualified, fiduciary financial advisor can prove helpful. By working with the seller to identify the seller’s most important priorities, goals, needs, values, and available resources, the advisor can help the individual position investable funds across a wide range of opportunities.
Often, a staged deployment strategy is advisable: the investor and the advisor work out a scheduled series of transactions to position assets for covering short-term needs, for ongoing income needs, and for long-term growth. Choices could include a mix of lower-volatility assets such as fixed-income instruments, equity investments (stocks or stock funds) covering a variety of industries and sectors, and even real estate in cases where that is appropriate. The key is to build a balanced portfolio that exhibits risk characteristics aligned with the investor’s needs.
This process is not a one-time affair, by the way. Proper financial planning involves consistent monitoring and revision. After all, life goals change, along with family composition, healthcare needs, and other priorities. The financial plan—including management of investments—should evolve at the same time in order to properly support the investor’s lifestyle and needs.
Your Optima advisor can be a valuable partner, both in pre-sale planning and post-sale wealth and tax management. If you or someone you know is considering the sale of a business, please give us the opportunity to create a plan that maximizes opportunities for a successful and satisfying transition.
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