/ 14 min read
Sep 16, 2022
You’ve set up a business and put in hours of work and resources. But, you’re feeling the urge to do something new. Whether you’re considering launching a new product, a new company, or just want some well-deserved time off, it’s key to know how the sale of a business is taxed.
We spoke to a leading business pricing and financial due diligence expert, Cindy Hao, on what the key tax implications are when selling a business in the United States. Cindy is part of OpenStore’s founding team, a Miami-based technology company with staff also in New York and San Francisco that specialize in buying Shopify stores.
We also consulted OpenStore’s financial controller and accountant, Michael U’Chong, as well as in-house legal experts who have worked on mergers and acquisitions at major U.S. law firms. They understand the financial, legal, and emotional implications around a business sale, and they’ve given dozens of e-commerce entrepreneurs a chance to sell their business.
This article is not and does not replace seeking out your own legal or financial advice as part of a business sale, but it gets you started on the concepts:
Do you pay tax when you sell a business? If you turn a profit, usually yes.
In order to sell your business, you’ll typically have to:
Prepare your business for sale
Structure the final deal
Put pen to paper
All the while maintaining your business' operations throughout
However, there’s one question that entrepreneurs looking to sell their Shopify stores ask Cindy a lot, ‘how much tax will I pay if I sell my business?’
The way you arrange your sales transaction will significantly impact the final sale price, and what share of that price will stay in your bank account.
Each case is unique. The type of business you own, your tax bracket, and even where you live will impact your tax rate on selling the business. Every asset valuation and deal structure is unique — we highly recommend you speak to a tax advisor about yours.
However, in this article, we’ll give you a broad overview of foundational concepts you need to know. It’s up to you to seek advice from your tax advisor before you take your next step. So, let’s get into the details and see how each of these factors affects your potential tax rate.
A capital asset is almost everything you possess and employ for private or commercial reasons. For example, personal-use items such as domestic furniture, or stocks and shares that are kept as investments.
You generate capital gain when you sell an asset for a price higher than its adjusted basis. If you want to sell one of your capital assets, the difference between the basis and the sales price is referred to as a capital gain or loss.
For example, the profit you generate when selling stocks represents capital gain, and it gets taxed. The same goes when you want to sell your business. The IRS’ publication 551 on the basis of assets contains information on calculating the adjusted basis.
When it comes to selling a business, the IRS doesn’t normally regard this as a sale of one asset. All of the assets of the company are considered independent. This rule, however, has some exceptions.
The IRS won’t treat your assets the same, which means that you won’t pay the same tax rate for all your assets. This is where things get a bit complex, and is definitely worth seeking tax advice over.
Not all of your business' assets will be taxed at the capital gains rate. Some of your assets may be subject to ordinary income taxation, which is a higher rate for most people. Sales of inventories, for example, are taxed at this ordinary income tax rate.
Your company’s assets can be taxed as long-term or short-term capital gains.
The profits from the sale of an asset that you've owned for more than a year are considered long-term capital gains. Generally, you’ll be taxed at a lower rate for long-term capital gains than for ordinary income. However, capital gains you’ve owned for less than a year will be taxed at the same rate as ordinary income (more on this later).
For many taxpayers, the maximum capital gains tax rate is 15%. This rate applies, as of the 2023 tax code, if you’re single and have a taxable income of $41,675 or more, but less than $459,750. The lower end varies in other cases, as well as the upper end:
$517,200 if you’re married and filing jointly, or a qualifying widow(er)
$488,500 if you’re the head of the household
$258,600 for married, but filing separately
Keep in mind these numbers change yearly, and this is how they stand at the time of writing. For the 2024 capital gains tax rates, you’ll need to get an update online.
However, if your taxable gain is above the listed limits, you may be subject to a net capital gain tax rate of 20%. There are other exceptions where it can go as high as 28%. Often, paying capital gains tax may lower your tax burden compared to paying regular income tax, but consult with your tax advisor and IRS documentation for definitive insights.
The tax for short-term capital gains is the tax rate you’ll pay when you’ve held an asset for a year or less. Earnings regarded as short-term gains are taxed at the ordinary progressive tax rate of the taxpayer. For example, the top individual federal income tax rate is still 37% for the 2023 tax year for any income that is earned above $578,125.
So, a short-term capital gain may also be taxed at a higher rate than your ordinary income. This is because it may cause a portion of your overall income to be taxed at a higher marginal rate. Corporate and income tax rates also differ by state, make sure you check them in more detail here.
To save money on taxes, you can maximize the number of assets classified as capital gains. However, you do not have complete control over asset allocation.
For example, according to the IRS, selling inventory generates ordinary income. However, selling capital assets that have been held for more than a year results in a long-term capital gain.
Asset allocation will differ depending on what kind of business you’re selling and this will determine how you can minimize the taxes you pay.
For example, if you’re selling an e-commerce business on Shopify, the asset allocation is not complex. The purchase price is allocated to the business assets that are mostly intangible. For example, a customer list, trademark, or domain — except inventory, which is often purchased at cost.
When it comes to optimizing your capital gains tax, you can choose between an asset sale or stock sale.
An asset sale is one of the options for buying or selling a business entity. The other option is a stock sale, where the seller sells all outstanding company shares to a new owner.
During an asset sale, the seller retains legal ownership of the business while the buyer receives individual assets. Individual assets can be things like:
machinery and equipment,
trademarks, patents, and the brand,
customer lists or special relationships with suppliers or clients,
Pricing expert Cindy Hao weighs in:
“Asset sales do not usually entail the purchase of the entity’s funds, and the seller usually keeps the long-term debt commitments. This type of selling is described as debt-free and cash-free. In cases where the outstanding debt has liens [a hold] on the assets being sold, the liens need to be resolved before the transaction.”
An asset acquisition agreement also usually includes normalized net working capital. Accounts receivable, inventories, and accounts payable all contribute to the working capital.
On the other hand, when a transaction is organized as a stock sale, also known as an equity sale, the acquisition leads to a transfer of ownership of the corporate entity itself. Still, the entity retains the same assets and obligations.
The acquirer purchases shares in the business and accepts the business as is, both in terms of assets and liabilities. Most of the target’s contracts, including the debt, immediately pass to the purchaser.
“At OpenStore, we use asset sales as this allows for a more certain, streamlined sale process,” Cindy explains.
The decision could depend on several factors:
If you’re selling a limited liability company (LLC): the transaction cannot be structured as a stock/equity sale if the business is a sole proprietorship, partnership, or LLC, because none of these organizational forms have stock. Therefore, consider how to structure your assets and consult with legal and tax specialists to optimize the tax implications when selling an LLC business.
The number of shareholders or unitholders of your company and how much they account for.
Your financial goals: you can sell the entire business or just a portion of it to take advantage of the present market valuation and hedge against a downturn while preserving a strong market share.
For example, if your business entity has two different stores, and you want to sell only one — an asset sale is for you. An asset sale allows you to only sell the assets of the targeted store, and remain the owner of the entire business — including the assets of the other store that you want to keep.
The deal structure of your business sale will affect your tax implications. With the assistance of expert financial advisers, both the buyer and seller will need to determine if an asset acquisition or stock purchase transaction aligns with their goals.
Different deal structures can help you avoid paying high taxes on a business sale. For example, if the buyer agrees to pay in installments, taxes might be deferred until the money is transferred.
Consider an installment sale: when the seller sells assets or stocks to another entity and gets at least one transaction in a separate tax year.
You may have already engaged in an installment sale if you've ever purchased a capital asset and paid for it across several tax years. For example, an office, complex hardware, or other company equipment are all examples of capital assets that rise or decline in price over time. They are often expensive items, and paying for them all at once is not always practical. The seller can divide the purchase into installments, lowering the amount of taxes they have to pay in one tax year.
This installment selling technique spreads out taxable earnings over several years. Gains are calculated as a proportion of gross profit, and the percentage is allocated to each payment as it comes in.
The gain is classified as income for every year when the seller gets a payment. (The seller may also be entitled to charge interest for the period of waiting, with the interest being taxed at ordinary rates.)
For example, Cindy details the two step installment sale setup for Shopify store owners:
“At OpenStore, we use a simple installment sale structure. We pay sellers 80% of the total sales price of the business upon closing, which can be as fast as one week after accepting our offer.
Once we've finished our two month transition period, we pay the remaining 20% of the deal.”
Not only does this make it fast and easy for sellers to move onto what's next, this also avoids the performance-based earnouts that many other e-commerce business acquirers and brokers use, and if it is timed over two tax years, can lead to tax savings for the seller.
If you are selling business assets, you need to familiarize yourself with tax rules about allocating asset purchase prices. The aim of these regulations is to stop taxpayers from allocating asset values in a way that gives them an unfair tax outcome when buying and selling a business.
The rules do this by incentivizing the transacting parties to agree on values and follow these in their tax returns.
In these scenarios, the way you divide the purchase price among your company assets will determine how much you pay in taxes. Your profits or losses on each asset will be determined by the allocation, as well as the buyer’s basis regarding separate assets.
Both parties should agree on the purchase price allocation in written form, following it in their tax filings afterward. If this occurs, the asset will be handled as if it had been sold and purchased at that price. It is advisable (but not required by the IRS) for parties to agree in writing on the allocation to avoid discrepancies in reporting.
The finalized price and asset value allocations don't need to be recorded in the sale and purchase agreement, but if they aren't, the procedure for setting that price and the timeline for doing so should be specified. (As mentioned before, the IRS requires consistency between parties in their reporting of the allocation on their tax forms.)
Both entities must also submit an asset acquisition statement (form 8594), with their individual income tax returns when a group of assets forming a company is sold or purchased.
Both sides must also declare the business’ total sale price and agree on how it will be allocated among seven distinct types of assets (IRS guidelines). The values are assigned using this allocation approach based on the market value of the assets at the time of the transaction.
“We prepare the asset allocation form for you shortly after close,” Cindy clarifies about selling your Shopify store to OpenStore.
The type of business being sold also determines taxation protocol during a sale. Rules vary depending on if the business is a single proprietorship, a partnership, an LLC, or a corporation.
Perhaps the most well-known of these business types, LLCs offer versatility, which includes multi-ownership configurations.
An LLC will have a standard vote because it's not regarded as tax status, but it can opt to be taxed like an S-corporation. As opposed to corporations, LLCs allow greater tax freedom, preventing the ‘double taxation’ of managers at the time of a business sale (one tax burden at the corporate level and another at the personal income level).
On the other hand, a standard corporation is subject to taxation both at the corporate and shareholder stages.
Following the sale of assets, the C-corporation pays business taxes at the regular rate. The C-corp pays a dividend to the shareholders so they can get the after-tax profits from the asset sale. The shareholder will be taxed at the capital gains rate on this dividend.
The IRS states that S-corporations are formed by owners in order to pass on company profits, liabilities, reductions, and credits to their shareholders. Shareholders who choose this form will disclose the stream of income and losses on their personal tax returns, while the IRS will tax them at individual income rates. S-corps are so protected from double taxation. However, they must pay some taxes at the entity level if they have, for example, passive income.
Overall, please consider OpenStore’s legal disclaimer:
The information provided in this article is for general informational purposes only and should not be construed as tax or legal advice. While we strive to ensure the accuracy and timeliness of the information presented, it is important to note that tax regulations and laws are subject to change and can vary based on individual circumstances. We strongly recommend that you consult with a qualified tax or legal advisor to address your specific situation and obtain personalized advice. Reliance on the content of this blog post is at your own risk.
If you run a Shopify store, whether on a dropshipping model or with your own supply chain, selling it can be a great financial decision. The sale can enable you to reinvest your gain in a new venture, purchase a new home, or take time off before deciding what to do next.
Make sure to understand the tax implications of your decision before you close the deal. A tax expert can help you understand some of the more complicated cases and develop a strategy for minimizing your tax liability.
OpenStore helps you eliminate many of the steps of the usual 6-12 month sales process, and gets you a free, no-obligation offer in one day, and cash in two weeks:
Our in-house legal team prepares all the paperwork to aid in this straightfoward asset sale process, paid in two installments (80% at close, and 20% after the 1-2 month transition period).
Alternatively, if you prefer a marketplace or broker, here are other options where to sell your Shopify store. We also spoke to OpenStore’s Frank Kosarek who has worked with the very first Shopify entrepreneurs that sold their businesses:
“There's never been a better time to explore an exit for your Shopify store. No matter what your reason for selling is, your options to sell have never been more accommodating for your unique circumstances.”
Find out what your Shopify store is worth
You don’t have to be looking to sell your Shopify store to use this form — just follow our simple steps for a free valuation.
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