Sell your business without having to pay tax on the profit!
Perhaps you have reached a point in your life when you think it is time to retire. Maybe you think it is just a good time to cash in on years of hard work building your corporation. Maybe you have been approached by others seeking to buy your corporation. Or, maybe you have even received offers but are unsure if the price is right. You can resolve this issue by obtaining the services of a qualified business valuation professional. Your accountant can calculate how much you will clear after taxes and your attorney can work out the agreements.
When you have reached the decision to sell all or part of your business, there is a way you can do it and delay the taxation for as long as you wish, even all the way to your grave! That’s right - never pay income tax on your gain.
A number of years back, Congress passed a tax provision that was intended to encourage employee ownership of corporations for which they work. This provision created Employee Stock Ownership Plans (ESOP’s) or retirement devices that would invest primarily in employer stock. ESOP’s are very interesting and provide some special opportunities.
Now you will see the power of ideas. One way ESOP’s can be used to great tax advantage is if you sell 30% or more of the stock of your company (you could sell 100%) to your company’s ESOP. You can get a result of no US income tax - ever. To get this special benefit, you make a tax election and reinvest the sale proceeds in securities of US operating corporations. You can diversify as much as you want. Tax is delayed until you sell the qualified replacement securities. If you never sell, you never pay tax on that gain! Neither you nor your heirs will owe income tax on that gain.
If your corporation does not have an ESOP (most do not) you can create one or possibly convert an existing employee retirement plan into an ESOP.
Where does the ESOP get the money to buy your stock? It leverages the transaction, just like most buyers of your business would do. The ESOP borrows from a bank. The corporation stock purchased is pledged as collateral and 100% of the payments made by the corporation to the ESOP (principal and interest) are tax deductible as contributions to the ESOP even though the ESOP uses the annual shareholder has tax-free cash as long as he wants it. As debt payments are made, the ESOP’s equity payments to amortize the debt
As a result, the selling shareholder has tax-free cash as long as he wants it. As debt payments are made, the ESOP’s equity in corporation stock grows, the employees become “owners” of the corporation as ESOP participants, and the corporation gets tax deductible payments to the ESOP.
Today, it’s not uncommon for some business owners to sell and their businesses —cashing in for a fortune! This is particularly true as many small technology businesses have sold out in initial public offerings (IPO’s) or have been courted by and sold to larger business, gobbling up everything in sight to gain market share.
Keep in mind that these transactions often generate huge taxable profits. Of course, with some thoughtful planning you should able to minimize your taxes and keep more for yourself.
Dale F. Hoffman, CPA, is a principal in the Philadelphia office of the accounting and consulting firm Parente Randolph. Hoffman specializes in tax matters. He can be reached at (215)972-2352.