You’ve made the decision to sell your Maryland-based business and enjoy the profits from increasing its value during your time of ownership. Before you complete the deal, you need to make sure that you secure your business sale legally by taking care of your obligations as a seller. One of these obligations comes in the form of the federal and state taxes that you incur when you sell your business to a new owner.
There’s no getting around the fact that you have to pay taxes on the sale of your business, but you have options that may reduce your tax liability. Getting legal help for the sale of your Maryland business makes for a smoother sale process and greatly reduces the risk of something going wrong. Here’s what you need to know about the tax aspects of selling your business.
The Tax Implications of Selling Your Business
Your business appreciates in value over time as you add new assets, expand operations, increase sales, and build it into something bigger. By the time you make the decision to sell, your business is worth much more than it was when you started. This is known as the basis of the value of your business, and an increase in value over this basis usually triggers capital gains taxes for you as the seller.
The business itself has become a collection of tangible and intangible assets that have value. The manner in which these assets can be sold can make it difficult for both buyer and seller to come to an agreement. The seller(s) has more of a tax advantage by selling their shares in the company to a buyer, whereas the buyer gets major tax advantages through an asset sale.
If you agree to sell the company through a stock sale, the buyer takes on the tax burden. The amount of tax incurred and how it’s paid depends on the corporate structure of the business, and adds a layer of complexity to the sale. Your goal is to pay the least amount of tax possible, so you keep more of the proceeds. In order to achieve this goal, you need the help of a Maryland business lawyer who can use existing tax laws to reduce your overall tax liability.
You’ll also pay taxes on the sale to the state of Maryland under a law known as the bulk sales tax.
How Your Corporate Structure Affects the Tax Rate on the Sale
Businesses that are structured as LLCs, partnerships, and S corporations are known as pass-through entities wherein the profits of the business flow through to the business owners, members, or partners. Taxes are paid at the personal tax level instead of the business level. In contrast, a C corporation may be at risk of triggering double taxation at the corporate and personal level after a sale and require a different type of sale to lower the tax liability.
The IRS has multiple rules for taxation that affect each type of corporation differently. It adds a layer of difficulty to selling your business you may not have anticipated. You also need to follow the IRS rules to avoid punishment for improper filing. This is why getting legal help for the sale of your business is worth the effort and cost, as it prevents mistakes from being made and ensures you pay the right amount of tax on your profits.
Classifying the Sale of the Business
As previously mentioned, there are two ways to sell a business: a sale of the assets or a sale of the company stock. Selling the assets is more advantageous to the buyer as it comes with tax benefits that help reduce ongoing tax liabilities. An asset sale gives the buyer the opportunity to take an immediate tax depreciation deduction on the assets and amortize the remaining balance over the next 15 years. This allows the buyer to get a 100% tax deduction over time as well as reduce their tax liability on future profits.
An asset sale can quickly become complex due to the fact the IRS requires all capital assets to be classified and valued. Capital assets include real property, inventory, depreciable property that’s used in the business, and any other physical asset owned by the company. The loss or gain in value of each asset has to be figured individually and reported to the IRS.
In contrast, sellers get more of a tax advantage by selling their shares and paying a capital gains tax. The IRS taxes the sale based on the increase in value over time at a rate of 15%. For example, the original cost basis of your business was $50,000, and now it’s worth $500,000. That means you’ve realized an increase of $450,000 in value, and you’ll pay $67,500 in taxes.
While this is a lot to pay in taxes, it may be less than the taxes that you would pay on an asset sale. However, a seller can also benefit from an asset sale by taking the profit from appreciation as capital gains. A seller is required to have ownership of a capital asset for at least 12 months before selling the business to trigger the capital gains tax rule.
This is a simplified overview of the two different types of business sales, and it shows that a decision as to the type of sale has to be made early on. In general, sellers prefer to sell their shares because they benefit from the capital gains tax rate. Buyers prefer an asset sale because they benefit from asset depreciation rules that greatly reduce the amount of tax they’ll pay over time.
Maryland Bulk Sales Tax and Local Taxes
The sale of your business is subject to a state tax law known as the bulk sales tax. It’s a 6% tax that’s applied to the actual cost of physical personal property that’s included in the sale. Sometimes an exemption can be applied to an item and keep it back from taxation. The tax is applied to items like computers, office furniture, supplies, and other items that aren’t part of the product or services sold by the business.
The Benefit of Getting Legal Help with Selling Your Business
Retaining a Maryland business attorney for the sale of your business enables you to exit your business with the least amount of stress and tax burden. Contact us at Lusk Law, LLC, to learn more about how we protect your interests during the sale of your business and make sure that you get the best possible results. We can help you learn more about the tax implications for your type of business, show you how you can legally lower your tax liability, and walk away with a decent profit.