How much tax will I pay when I sell my business in Connecticut?
Let’s discuss potential income tax consequences of what could well be most entrepreneurs’ most valuable asset: their business. As in any state with significant tax rates, it is important for business owners to contemplate how much tax they will pay when selling a business in the state of Connecticut. After all, it’s not what you sell your life’s work for, it’s the amount you actually get to keep from such sale.
What you will learn:
· The type of taxes you are likely to pay when selling a business
· Why the sales price of the business is not the only thing that matters
· Tips for negotiating the sale price of your business with a buyer
· Ideas on selling a business to your employees
· Considerations regarding the timing of the sale of your business
Now that we’ve established the major points we will cover about selling a business in the state of Connecticut, let’s begin.
Selling a business and Connecticut capital gains tax
Before we begin, it’s important to acknowledge that in the case of the sale of your business, it is of high importance to seek out a good tax advisor for your own particular situation. Many businesses within the state of Connecticut tend to be professional service providers such as lawyers, doctors, and accounting and financial services companies. According to the Tax Foundation’s 2021 State Business Tax Climate Index, Connecticut ranks 47th in the country. Connecticut scored so poorly due to its onerous personal and property taxes, as well as the fact that it levies a gift tax on its residents.
You probably are already familiar, but let’s review some of the key terms related to how much tax you are likely to pay when you sell your business. Let’s start with the basics.
What is capital gains tax, and why does it matter to a business owner?
Capital gains tax is paid on the sale of assets. If you are a business owner, your business is considered an asset under current tax law. Selling a business is a taxable event.
If your business has appreciated in value since you assumed ownership (or started it), you are liable to pay taxes on the difference between the current value of the business, and its cost basis. This is called a capital gain.
Selling within one year of the time at which you assumed ownership of this asset will generate short term capital gains tax. If you sell your business after a year of owning it, you’re given long term capital gains tax rates.
Capital gains can bring significant potential tax issues upon sale, and we suggest discussing the implications of any sale with your tax advisor before undertaking this important transaction.
Ordinary income tax is assessed on any type of income, earned by either a person or a company. A few hypothetical examples of earnings that are possibly taxed as ordinary income are wages, tips, rents, and interest income.
As the state of Connecticut has a fairly steep ordinary income tax rate, lessening the impact, if possible, should be part of any overall tax strategy.
Sale price is only part of the battle
In most cases, the ownership of the business, be it sole proprietorship, LLC, Sub S Corp, C Corp, or a partnership, will greatly impact the taxes that may be owed by the seller should you have a gain on the sale of your business. As for many people this is a one-time liquidity event, the seller will certainly want to reduce his or her taxes to the lowest amount possible.
In some cases the buyer can benefit from a different structure than the seller would want. In many circumstances, the buyer and sellers not only have to negotiate the actual purchase price, but also what the buyer is actually buying.
For example, should stock in a C-Corporation be the instrument of sale, the owner is taxed upon the value of the stock above his cost basis, which usually is quite low if she or he began the business. However, if he or she sells the assets of the corporation, such as inventory, it’s possible that the corporation will pay tax on the sale. The shareholders, usually the owners, may pay again when they take the funds out of the corporation. The inventory piece may also be subject to the higher ordinary income, not capital gain, tax.
Each piece of the eventual sale has income tax implications and in general the seller is seeking as much capital gain treatment as possible. Conversely, the buyer may well be better off buying assets that will generate ordinary income to the seller. Ordinary income tax rates are usually much higher than capital gains tax rates, hence the reason to negotiate beyond just the purchase price.
For example, the goodwill of a business may have favorable tax treatment for the seller, but may not be desirable for the buyer. We’ve seen cases where the CPA or tax advisors for both parties are the ones who really negotiate the final terms of the sale once the owners have decided to move on.
In an S corporation, which are pass through entities, the tax issues may be similar but the partners would pay the resulting taxes upon sale as those gains would pass through to them, not the entity. Therefore this is not a simple calculation and in many businesses of any size, the buyer and seller should negotiate not only the price as I said, but what they are really buying.
Selling a business to employees
In some cases, C-Corporation owners may also want to sell to their employees under an ESOP, or Employee Stock Ownership Plan. This provides monies to the seller and allows the employees to take over ownership. The seller may be able to defer the tax on a portion of the gain. In our experience, ESOPs don’t often execute because the owner doesn’t want to give up control.
Timing the sale of your business
Some sellers negotiate installment sales of over a year in order to spread the tax implications out over that time span, be it one or seven years or more, to hopefully maintain lower tax brackets along the way. The major risk, of course, is that the buyer becomes insolvent or can’t make all the payments, so that would also figure into the total purchase price.
If the business owns investment real estate, it’s possible to transfer such to the buyer on a tax free exchange basis under Internal Revenue Code Section 1031. But again, even though you can possibly do this with your businesses as well you should have a competent tax advisor to make sure that all of the requirements are met.
The sale of a business is a complicated issue, and good counsel on what you get to keep should be reviewed and calculated before actually consummating the sale. It’s not just the question of the dollar amount. Remember that most people only sell a business once in their lifetime, and the only thing that really matters at the end of the day is how much you get to keep after taxes.
It is prudent to have the right people on your team if you are selling a business in the state of Connecticut. As we’ve said before, consult a tax advisor for recommendations specific to your situation.
We are a financial advisor firm based in Farmington Valley, Connecticut, serving individuals and families in Farmington, Avon, Simsbury, Canton and Granby, the greater Stamford and Hartford areas, and across the United States. We typically help them with retirement planning, investment management, and other financial consulting related services, one of which is advising them on overall tax strategies.
If you are a business owner in Farmington, Avon, Simsbury, Canton, Granby, or any other location in the United States, and would like to discuss the financial impact of selling your business, please reach out through the contact form below.
Walczak, Jared, and Cammenga, Janelle. 2021 State Business Tax Climate Index. Center for State Tax Policy. Tax Foundation. Retrieved on December 16, 2020 from https://files.taxfoundation.org/20201021092452/2021-State-Business-Tax-Climate-Index.pdf
Securities offered through Royal Alliance Associates, Inc. (RAA), Member FINRA/SIPC. RAA is separately owned and other entities and/or marketing names, products, or services referenced here are independent of RAA. Insurance and advisory services are offered through Karn, Couzens & Associates, Inc.
KC+A does not provide tax, legal, or accounting advice. No information on this site or any information on websites or links to websites provided here should be construed as individual tax, legal, or investment advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.