A business owner works tirelessly to build his or her closely-held business. After long hours and substantial risk taking, the business owner has created an asset that, if transferred efficiently, could provide financial security.
With so much wealth trapped in a closely-held business, there is a real fear that once an owner exits their business they will outlive their money. This fear can be the largest obstacle for business owners to overcome when transferring or selling their company. However, with proper education and planning, business owners can position themselves to make a confident decision.
When the owner faces the decision of how and when to leave their closely-held business one of the key components is how to reduce the level of taxes triggered by the exit. Combined federal and state tax rates can be as high as 40 percent. Therefore, early tax planning is critical in helping achieve an owner's financial goals.
When exiting a business there are five major decisions that the business owner will make over the life of his career that can have a profound effect on the amount of taxes he or she will eventually pay when the transaction is executed.
Entity formation — A key indicator in determining the tax ramifications for the buyer and seller is the entity formation. Most companies are structured as either C-corporations, S-corporations, LLCs, partnerships or sole proprietorships. With the advent of the LLC, the C-corporation is becoming somewhat extinct in the closely-held business arena. However, a considerable number of C-corporations are still in existence today. These entities require a significant amount of planning in order to achieve the business owner's financial goals upon liquidation.
Deal structure — Generally, transferring a business is accomplished through either an asset sale or equity/stock sale. Each method proposes advantages and disadvantages to both the buyer and seller and is often subject to much negotiation.
Of paramount importance to the buyer is minimizing unknown liabilities, maximizing step-up basis in assets, speeding the write off of assets purchased through various depreciation methods, minimizing the purchase price, stretching out the payment terms, and obtaining adequate representations and warranties.
Conversely, the seller is trying to maximize the sales price while reducing the tax burden and accelerating payments from the buyer in order to minimize the financial risk of non-payment.
Achieving these goals by both parties can often be a long and arduous process.
Tax code — The Internal Revenue Code can be your best friend or your worst enemy. With the proper strategy, the code can be used to the owner's advantage by utilizing various techniques to reduce, defer or eliminate taxes altogether. It's not so much what an owner gets in the transaction that is of key importance; it's what the owner keeps.
Asset protection — All too often asset protection is equated with insurance or other financial products. However, there are times when risks are not insurable, or a claim is so high that it exceeds your coverage amounts. Utilizing various entity types with protective characteristics can provide business owners with the level of protection that is needed from creditors and predatory lawsuits.
Financial planning coordination — All too often we see that business owners have taken the initiative to start planning for various aspects of their lives, such as life insurance, wills and trusts, and a buy-sell agreement. Lack of coordination causes unintended consequences.
FROM HARTFORDBUSINESS.COM
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