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Death and taxes are two of the suckiest and most certain parts of life. But guess what? While there’s no known antidote to death (aside from Indiana Jones’s Holy Grail), there is an antidote to taxes. Yup, that’s right. You can minimize or even eliminate capital gains taxes when you sell your online business. Quiet Light got the fascinating and 100% legal details from tax planner extraordinaire, Shanyn Stewart.
IN THIS POST
In 1789, Benjamin Franklin wrote in a letter, “In this world, nothing can be said to be certain, except death and taxes.” Of course, for many folks, taxes aren’t-so-certain. With headlines like “Amazon pays zero taxes,” many of us are wondering how it’s possible to avoid the inevitable and mighty hammer of Uncle Sam.
But for the sake of argument: what if you could pay significantly less—or even zero—taxes when you sell your online business? All within the confines of the law?
While the grim reaper catches up to us all eventually, we don’t have to sacrifice our hard-earned profits to the red, white, and blue reaper. Death is a certainty, but with a lot of preplanning, business owners can mitigate or avoid capital gains tax.
You’ve put a lot of time, money, and tears into your business. When you sell your online business, you might think it’s a perfect time to cash out on your hard work. You’ve earned it, right? Of course you have. The issue is that the government wants a big, fat hunk of your hard work. Depending on your business and the deets of the deal, the feds and the state could tax you as much as 30% on your biz sale.
I’m all for paying what you owe, but 30% of a $2 million sale is absurd. But a lot of sellers don’t know that they have options, so they bite the bullet for the sake of getting cash in hand ASAP. Running a business isn’t about giving up or giving in, especially to people who want a huge cut of your business sale.
Quiet Light talked about this very issue with Shanyn Stewart, a professional tax preparer for multi-million dollar brands. She says that business owners shouldn’t take taxes as a given.
If you’re smart about how you structure your deal, you can opt for non-cash options that put more moolah in your pocket over time, limiting Uncle Sam’s grabby reach into your pocketbook. For example, one of Shanyn’s clients had an $11.6 million biz for sale. Shanyn’s strategies put $3 million more into her client’s pocket at the end of the deal. Not too shabby, eh?
Learn how to get the money you deserve for your business, how to protect your finances, and get more money on the table during a business sale with clever deal structuring.
Shanyn Stewart is the Chief Strategist at Advanced Accounting, a tax planning firm that specializes in business acquisitions. “We do proactive tax planning for our clients,” she says. Her mission is to help sellers stick it (respectfully and legally) to Uncle Sam. Shanyn’s so dang good at her job that she claims she can structure a sale where a seller pays $0 in taxes.
Shanyn’s approach is different because she’s all about being proactive. While there are some actions you can take to mitigate taxes after a business is sold, Shanyn says the key to crazy-huge tax savings is to plan ahead of time. That’s the key to legally preventing the IRS from getting a big, fat check from your business sale. “Keeping a taxpayer in compliance is in and of itself a full-time job,” she adds.
If you’ve hired a tax planner in the past and they told you there was no way around paying taxes, you aren’t alone. Shanyn says many tax specialists tell their clients to suck it up because they don’t know there are other ways to mitigate taxes.
So no, taxes aren’t an inevitable part of selling your business. You don’t have to suck it up. If you’re selling a multi-million dollar brand, you can keep more cash in your pocket with creative accounting—that won’t land you in hot water with the IRS.
I once had an accountant who joked, “You know the best way to save on taxes? Earn less.” That’s certainly true, but according to Shanyn, there are other lesser-known ways to reduce your capital gains tax burden. Before we get into the nitty-gritty strategies to save on taxes, Shanyn recommends you keep things 4 things in mind first.
1. Don’t DIY This One, Folks
Hopefully, this goes without saying, but Shanyn makes it very clear: do not try to DIY your capital gains tax mitigation. “You’re not going to your local mom-and-pop accountant or lawyer for this, either,” Shanyn says. For starters, the IRS tax code is thousands of pages long. If you’re an entrepreneur, you probably don’t have:
- The time
- The know-how (sorry, but it’s true)
- The experience
… to tackle something as complex and scary as the IRS. And your homegirl at H&R Block probably doesn’t, either.
You have to know what you’re legally able to do to limit taxes. Otherwise, if you get something wrong and run afoul of the law, you’ll earn an orange jumpsuit and an empty bank account.
For tax planning, you need to suck it up and hire an experienced pro. You’ll have someone walk you through a proven process and help you stay IRS-compliant, which is key.
2. Plan your exit ahead of time
Shanyn has some clients approach her at the very end of a sale, or after they’re purchased a new business. While you can mitigate taxes in these situations, they aren’t going to net you a lot of savings because they’re done at the last minute.
According to Shanyn, the best tax planning is done ahead of time. “We’ve got 3 or 4 strategies in place, and that’s where preplanning comes in,” she says. If you want to not only get more money from your business sale, but minimize taxes on that sale, you need to plan your exit very carefully.
It sucks, because if you’re thinking about selling, you’re likely already tired and emotionally fried, but preplanning will save you thousands of dollars, funding a better post-exit lifestyle.
Don’t believe me? Shanyn just had a client approach her. They claimed that they wanted to sell their $10 million biz ASAP. But after looking over the financials and the deets, Shanyn realized they would only get $6 million for the sale, which meant the seller had to start over.
Don’t do that to yourself.
One of the four pillars of a valuable business is documentation, and that takes planning. If you wake up and decide to sell one day, you’re shooting yourself in the foot by missing out on kickass tax savings and other business improvements that will net you more money.
Planning ahead is the key to mitigating taxes. That’s because none of Shanyn’s ninja-level strategies will work once you have a binding contract on your business. Once there’s a contract (and that includes temporary agreements like LOI), Shanyn can’t help you. “We like there to be no LOI. We want zero questions from any government organization or court,” she adds.
So, when’s the best time to plan your exit to save on taxes? Both Quiet Light and Shanyn say 12 – 24 months is ideal. The fastest Shanyn’s done her process is 60-90 days, but if you want to maximize the benefits of tax planning, 12 months is ideal.
That isn’t just for implementing your capital gains tax strategy; it’s so Shanyn has time to educate you. Taxes are really complicated, and it’s important to know why and how things are happening so you don’t feel taken advantage of. Always partner with a tax pro who’s going to educate you. You want to be a co-pilot, not a passenger.
3. Start With Your Cost Basis
To get the most tax savings when you sell your online business, you have to understand how capital gains tax works. “When you sell your business, you have a capital gain,” Shanyn says. The concept starts off pretty simple: if you buy low and sell high, you pay taxes on the difference between the two. If you buy a business for $100,000 and it’s worth $500,000, you pay on the $400,000 difference as capital gains tax.
But, as with everything in life, it’s not that simple. What if you didn’t buy the business? What if you bootstrapped your business from the beginning? How the heck do you calculate the difference at that point?
Shanyn says cost basis is what you’ll use to determine what to subtract from your business’s value (decreasing taxes). What did you purchase the business for, if you bought it? If you didn’t buy it, how much did you invest in that business?
A cost basis is any asset that you paid for to grow the business. You need to know your cost basis before you plan to sell because it can help you with tax liability. “The difference between your sale price and your basis is where you’re going to get capital gains,” Shanyn says.
The following purchases often count as basis:
- Building or leasing office space
- Furniture and fixtures
- Patents and copyrights
Unfortunately, if you have a service-based business or other lean operation, you probably will have a basis of zero. If you sell products with an eCommerce store, you have more wiggle room to use cost basis.
But hey, it’s still worth chatting with a tax planner; depending on the circumstances, you may be able to write off certain expenses as basis. For example, if you had a content site and hired writers to get the site off the ground, it might count as basis.
The key is to mark these expenses as assets. If it’s a depreciating asset, you can count it as cost basis and that will help with taxes.
Put simply, capital gain is the difference between your sale price and your cost basis. It’s the value of your business after the expense of assets. In addition to this pesky capital gains tax, you’re also hit with a 3.8% tax on net investment income, which means Uncle Sam can really stick it to you here. That’s why tax planning is so important, and why you have to understand how this stuff works, even if you aren’t a numbers person.
4. Clean Up Your Balance Sheet
If you murmur the phrase “balance sheet” to a group of entrepreneurs, you’ll probably see them roll their eyes. For many business owners, the balance sheet is an annoying, cryptic report that they know is important, but don’t want to deal with.
However, it’s important to remember that your balance sheet is a tool for mitigating your capital gains tax. “Understanding your financials is so important,” Shanyn says. While some people expense stuff left and right, you need to be strategic with your balance sheet. Look at your exit strategy (AKA how you want to live after you leave the business), and let that inform what you write off as an expense on the balance sheet.
There are so many deal structures and strategies you can use to be creative with your tax planning. But it’s hard to run your race if you don’t know where the finish line is. Always plan your balance sheet with your end goal in mind. For example, instead of expensing something once in a year, you can expense it over time.
Before we dive into Shanyn’s tax saving strategies, I want to point out that this isn’t just for people who want to sell an online business. Buyers can apply these strategies to newly-acquired businesses, too. In fact, it’s a smart move that will help you save money on taxes every year you own the business, as well as during your eventual exit.
You’re coming into a business where you’re going to add value. This upfront investment in the company counts as cost basis. If it’s adding value to the business, it’s a write-off that can benefit you for years to come.
While Shanyn’s work is largely with sellers, it should perk up the ears of buyers, too. You’ll eventually need to sell and exit your business, and it helps to know how you can do that without losing your shirt.
Now that we have a better understanding of how these tax savings are possible, let’s dive into Shanyn’s 4 favorite tax mitigation strategies for businesses. Keep in mind that these strategies don’t work in a vacuum; for the best results, you’ll want to use a combination of tax mitigation strategies to see big savings.
1. Installment Sale
Let’s say you’re selling your business for $2 million with $100,000 of cost basis. Instead of paying a 22% tax on that $1.9 million as soon as it hits your bank account, Shanyn recommends an installment sale to mitigate thousands of dollars in taxes. “You defer the gain until you actually receive those payments, so taxes are divided throughout the years,” she says.
In an installment sale, you don’t receive the full $1.9 million in hand once you sell the business. Instead, you receive equal payments for your business sale over several years. So if you sell your business in 2020 for $1.9 million, an installment sale would pay you that $1.9 million over the course of, say, 3 years instead of immediately.
I can hear the alarm bells in your head going off already, so let me explain. Installment sales are beneficial because:
- You aren’t taxed on the full tax amount all at once.
- It gives you a recurring source of post-exit income, creating a small pension for yourself.
- You can pair it with other kickass tax savings strategies to save even more money.
Basically, installment sales mean you divide your tax payments up over several years. That means you aren’t paying millions in taxes in one year.
Of course, there are some downsides to installment sales. If you’re publicly traded, you can’t do an installment sale. And there’s also the issue that you aren’t getting all of your money at once, which a lot of people don’t like. “The downside of an installment sale is that you’ve deferred the tax, but you don’t have all your money,” Shanyn says.”
2. Structured Sale
What if your buyer doesn’t pay those 3 installments of $1.9 million? What if the buyer tanks the business and can’t pay you back? Can you collect that money anyway? Fortunately, as a seller, you’ve got a lot of options. (By the way, this next tidbit will only work if your biz is in the $100,000 – $5 million range.)
A structured sale makes installment sales less scary. Structured sales bring in a third-party, like a lender or insurance company, to help with an installment sale. The buyer will pay some or all of the cash upfront to the third-party in the structured sale. Your buyer will have an obligation to make payments to that third-party, so you don’t have to hunt the buyer down for payments.
Structured sales help mitigate the risk of installment plans. As you get payments from the third-party, you’ll pay capital gains taxes on a more reasonable, spread out schedule.
The downside is that you’re still just putting off tax payments, and you won’t have all of your money in hand. What’s an entrepreneur to do?
3. Monetizing Loan
Shanyn suggests a third option for entrepreneurs who want to reduce capital gains tax and get cash in-hand after the sale. This is called a monetizing loan, and it’s usually paired with an installment sale. “We take an installment sale and defer taxes for 30 years,” Shanyn says.
Monetizing loans can get really complicated, but the point of them is to get money to you immediately after selling an online business. This is perfect if you need cash in your pocket right now to start another venture.
To do a tax-friendly monetizing loan, you set up an installment sale. The difference is that you defer taxes on your business for 30 years by using a loan.
The magic of a monetizing loan will happen when you close on the business. You’ll sell the business to your buyer and work with a third-party lender to get a lump-sum payment.
The third-party lender can give you a loan equal to 93.5% of your business’s value, putting nearly all sales proceeds in your pocket immediately. You can do this without paying taxes immediately on the proceeds because loan proceeds aren’t taxable.
Boom! Now you have cash in hand that’s nearly equal to the sales price of your business, and you can use it however you want—sans capital gains taxes. Monetizing loans last for 30 years, at which point your third-party insurance company or lender pays you the full amount for your business, which you then turn around and use to repay the loan, plus tax.
The cool thing about this is that taxes will be different in 30 years. If inflation continues at 2.5% every year, the tax on $1 million would be equivalent to $94,000 in 2019.
The key is to make sure the monetizing loan is non-recourse, which means the lender can’t come after you for unpaid interest. Always work with a reputable lender and have tight legal agreements in place around the loan. Do your due diligence and everything should work out a-okay.
4. Charitable Remainder Trust
Shanyn’s final tax-saving strategy is one we see a lot from upper-crust folks: charity. This is important because charitable organizations can sell appreciated assets without paying a dime of taxes on the capital gains. “It’s a way that we can eliminate a lot of taxation,” Shanyn says.
You don’t need to start your own charity to take advantage of this, either. Shanyn says you can establish something called a charitable remainder trust, where you transfer the business assets into the trust.
The trust will then sell the assets to your buyer tax-free with zero capital gains. The trust will then reinvest the payment from your asset sale, paying you after tax. This can minimize a lot of taxes just by itself!
(P.S. You can’t do this legally if you have a contract on the business, so remember, preplanning is key!)
When you sell an online business, it’s tempting to take the road you’re familiar with. Whether you just want to be rid of your business or you’re already under contract, neglecting to plan your exit can cost you thousands of dollars.
Shanyn says most business owners don’t want to do tax planning because it sounds confusing; they assume their tax planner is trying to pull a fast one on them. Healthy skepticism is one thing, but when embracing legal alternative deal structures means saving thousands of dollars, it’s time to pay attention.
In reality, restructuring your sale is a win for everyone. Your buyer isn’t going to give a damn what you do, as long as they get the business. You get more money in your pocket and don’t have to run the business anymore. Win!
The key is to give yourself time to do tax planning the right way. “If we have enough time before the sale of the business, there’s a lot of planning we can do,” Shanyn says. Spend at least 12 months structuring your business to save on taxes. This will also give you more time to get educated on tax planning, so you know what’s happening with your sale and why. You might not be able to avoid paying taxes completely, but this strategy can still help you save money during a business sale.
Are The Savings Enough To Warrant A Tax Planner?
But do you save enough from the sale itself to warrant hiring a tax planner like Shanyn? She says yes, and has an excellent example.
Shanyn’s client was an entrepreneur in Michigan. He was selling his $12 million business that included molds and dyes. His cost basis was $360,000, so his capital gain was $11.6 million.
The biz owner was staring down the barrel of some hefty net investment income tax, depreciation, and state tax. Without tax planning, he would lose $4.3 million just to taxes, taking home only $7.3 million. With these strategies, Shanyn increased the seller’s profit by $3.3 million by reducing their tax liability, so he went home with $10.6 million.
The key? Planning ahead. By planning in advance and layering different tax strategies, Shanyn secured 5 years of $2.12 million payments for her client. He saved millions in taxes, which more than paid for a tax planner.
Taxes might seem inevitable, but there are plenty of ways to reduce or avoid paying taxes entirely. I know it sounds nerve-wracking to challenge the IRS’s claim to your business assets, but with the right pro at your side, it’s possible.
Remember, look at your goals and plan with your exit in mind. That’s not only going to net you more proceeds for the long haul, but give you a pension that will make life a little easier for a while. Figure out what’s important to you and work with a tax preparer to make it happen.
By hiring a pro, planning ahead of time, understanding cost basis, and cleaning up your balance sheet, you’ll be prepared to save more on taxes. Chat with your tax preparer about strategies like an installment sale, a structured sale, a monetizing loan, or a charitable remainder trust to legally pay fewer taxes.
This sounds complicated, but with the right team on your side, it’s not only doable, but you’ll be glad you put in the extra elbow grease. While you can’t avoid the grim reaper, you can avoid Uncle Sam from swiping more money than he should from your bank account. Isn’t it time to keep more of the money you earn?
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