How Do Capital Gains Taxes Affect the Sale of a Business in Illinois?

The prospect of selling your business can be exciting, providing the opportunity to capitalize on your hard-earned work. It may be that you are selling your business to retire, or to start another venture. Whatever the reason, many factors impact the decision to sell a business, and the details of the transaction. One key factor that affects the sale of a business is taxation. 

Capital gains taxes can eat up the proceeds of the sale if you do not put in place careful strategies to mitigate taxation. In fact, when you get an offer, you should first consider the potential tax implications of the sale to determine how best to structure the transaction. To minimize capital gains taxes that affect the sale of a business, contact an experienced Naperville, IL business law attorney. 

What Are Capital Gains Taxes?

Capital gains taxes are the taxes that are assessed for the sale of stock and other investment assets when those assets are sold for more than what you paid for them. There are two types of capital gains taxes: short-term capital gains taxes and long-term capital gains taxes. Short-term capital gains are assessed on assets that you owned for less than one year, and are taxed at the same rate as ordinary income at the federal level. Long-term capital gains taxes are those that you held on to for longer than one year. The Internal Revenue Service (IRS) taxes long-term capital gains at a lower rate of zero, 15 percent, or 20 percent. In addition, Illinois taxes all capital gains as ordinary income with a tax rate of 4.95 percent.

How Are Capital Gains Taxes Calculated In a Business Sale?

Business sales are usually subject to federal and Illinois long-term capital gains taxes. How a business is structured will affect the imposition of capital gains taxes. For companies structured as Limited Liability Companies (LLCs), partnerships, and S corporations, the IRS will look at the business’ individual assets to determine how to apply capital gains tax rules. That means that the IRS will not tax the business as one entity, but rather will impose capital gains taxes based on the individual assets of a company such as real estate, intellectual property, tangible assets like equipment and supplies, and any leases or contracts. The IRS will look at each individual asset to determine the length of time the company has held that asset and the applicable capital gains tax rate. It may tax gains from some assets as capital gains and others as ordinary income, depending on the type of asset being transferred.

Because of this, there is an especially significant component that can impact capital gains taxes in a business sale, and that is how the purchase price is applied or allocated to each business asset. For this reason, a big component of negotiating the purchase price will be allocating the price of each asset. The seller will want to balance the desire to get as much money as possible for each asset with the capital gains tax implications of pricing the asset at a higher rate. 

How Can You Minimize Capital Gains Taxes on the Sale of Your Business?

Although it is likely not possible to avoid capital gains taxes altogether on the sale of your business, it is possible with careful planning to reduce or offset capital gains taxes using a few strategies, including:

Avoiding Short-Term Capital Gains 

Since short-term capital gains taxes are higher, it pays to ensure that you wait to execute the sale of your business until you have held all the assets you have acquired and which will be part of the transaction for longer than one year, which puts them into long term capital gains territory. 

Considering an Installment Sale

Similar to selling your car or home for installments, an installment sale allows you to sell your business and receive payment in installments, thereby spacing out your tax liability as well. 

Selling Your Business Via a Charitable Remainder Trust

The Charitable Remainder Trust (CRT) is a tax-exempt trust. To utilize it for the sale of your business, you would transfer the ownership of your business to the trust, and the trust would then sell your business. Because it is tax-exempt, the trust would not pay any capital gains taxes when you make the sale. Instead, it would reinvest the proceeds into assets that produce income for the trust beneficiaries until the end of the trust term, after which time the trust assets would be distributed to your charity of choice.  This strategy requires careful planning and legal oversight to meet IRS requirements for tax exemption.

Selling to Employees

If you have structured your business as a C-corporation, you can sell the business to your employees through an Employee Stock Ownership Plan (ESOP). Not only does this remove the need to look for a buyer, but you can also put the proceeds from the sale into a tax-deferred investment plan. 

Making a 1031 Exchange

This IRS section allows you to reinvest the proceeds from the sale of a qualifying business into a similar kind of asset while deferring capital gains taxes with a like-kind exchange under IRS section 1031. This would be a great option for someone seeking to use the proceeds from their business to start a new venture. 

If the sale of your business includes real estate, a 1031 exchange may allow you to defer capital gains on the real estate portion by reinvesting in similar property.

Selling Your Business in Exchange for Rollover Equity

This strategy involves investing some of the proceeds from the sale of your business in the buyer’s new company in exchange for equity in that company. You would pay capital gains only on the equity portion when the buyer sells the new company. An additional benefit of this strategy is the potential to increase your earnings if the new company does well. This strategy involves partial cash-out and partial reinvestment, and carries risk, so you should consult with a lawyer before making any decisions.

Call a Naperville, IL Business Law Attorney

If you are selling your business in Illinois, you need experienced Naperville, IL business law representation to guide you throughout the process. At the Gierach Law Firm, Attorney Denise Gierach advises clients on the sale of their business and on the legal issues that must be carefully considered for a successful transaction. Call the law firm at 630-756-1160 to speak to attorney Gierach about the sale of your business. We can help you strategize a successful transaction.