FAQ: How am I taxed when selling my Shopify business?

Picture this. You’ve set up your Shopify store and put in hours of work and resources to make it the success it is today. But, you’re feeling the urge to do something new, the next big step.

It’s the entrepreneur’s itch, and we don’t blame you. Whether you’re considering a new product, a new company, or just want some well-deserved time off, selling your business is a big step to getting you there.

If you’re looking to sell your much-loved Shopify store, there’s a lot to prepare, but this article’s got you covered.

Tax info to know before you sell your Shopify business

When it’s time to sell, you’ll have to put in the leg-work for finding a buyer, structuring that final price, and agreeing on the small print. However, there’s one question that will inevitably come up every time: “if I sell my business, how much tax will I pay?”

The way you arrange your sales transaction will significantly impact the final sale price, and the share of that price that will stay in your bank account.

Each case is unique. The type of business you own, your tax bracket, and even where you live, all impact the outcome of your final profit.

When you sell a business, the taxation can depend on several factors, each of which we’ll cover here.

Before we go any further, we must stress that each value of business assets and business structure case is unique—we highly recommend you speak to a tax advisor about yours. There are few businesses that truly want to discuss taxes as it’s such a complicated topic.

However, in this article, we’ll give you a broad overview of everything you need to know. It’s up to you to seek advice from your tax advisor before you take your next step.

Right! Let’s get into the details and see how each of these factors affects your potential tax burden.

What are capital gains?

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 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. Publication 551, Basis of Assets, contains information on calculating adjusted basis.

When it comes to selling a business, the IRS doesn’t normally regard this as a sale of one asset. All 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 the ordinary income tax rate.

Your company’s assets can be taxed as long-term or short-term capital gains. Let’s explore the difference.

What is long-term capital gains tax?

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.

For most taxpayers, the maximum capital gains tax rate is 15%. This rate applies, as of the 2021 tax code, if you have a taxable income of $80,000 or more, but less than:

• $441,450 if you’re single
• $496,600 if you’re married, filing jointly, or a qualifying widow(er)
• $469,050 if you’re the head of the household
• $248,300 for married filing separately

Keep in mind these numbers change yearly, and this is how they stand at the time of writing this piece: the 2021 capital gains tax rates. For the 2022 capital gains tax rates, you’ll need to get an online update.

However, if your taxable gain is above the listed limits, you will be subject to a net capital gain tax rate of 20%.

Note: There are also some other exceptions you can find on the IRS website.

Paying capital gains tax lowers your tax burden compared to paying regular income tax.

What is short-term capital gains tax?

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 rate of the taxpayer, with the top individual federal income tax rate being 37% for the 2021 tax year.

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.

Business asset allocation and taxes

To save money on taxes, sellers want to maximize the number of assets classified as capital gains. However, the seller does 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.

The good news is, in the case of selling your Shopify business, 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.

There are also options for an equity sale or stock sale. Let’s explore the differences.

Asset sale vs. equity sale (stock sale)

An asset sale is one of the options for buying or selling a business entity. The other option is equity sale, where the seller sells all outstanding company shares to a new owner.

During an asset sale, the seller retains legal ownership of the firm while the buyer receives individual assets. Individual assets can be things like:

• Machinery
• Trademarks
• Brand assets
• Trade secrets
• Customer lists
• Inventories

“Asset sales do not usually entail the purchase of the entity’s target'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.” – Cindy Hao, OpenStore.

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 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.

The OpenStore way: we use asset sales as this allows for a more certain, streamlined sale process. Read on for more on this.

Is asset sale better than equity sale for you?

The decision could depend on several factors:

• Your business structure. The transaction cannot be structured as a stock sale whether the firm is a sole proprietorship, partnership, or limited liability (LLC), because none of these organizational forms hold shares.
• The number of shareholders or unitholders of your company and how much they account for.
• Your financial aim. You can sell the entire firm 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.

Let’s take a look at this example. If your business entity has three 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 stores you want to keep.

The structure of your business sale affects your tax obligations. With the assistance of expert financial advisers, both parties will need to determine if an asset acquisition or stock purchase transaction is a fit for their selling and purchasing goals.

Selling my Shopify business: deal structure and taxes

A deal’s structure may have an impact on your tax burden too. If the buyer agrees to pay in installments, taxes might be deferred until the money is transferred.

When the seller sells assets or stocks to another entity and gets at least one transaction in a separate tax year, it is called an installment sale.

Note: you've engaged in an installment sale if you've ever purchased a capital asset and paid for it across several tax years.

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 is also entitled to charge interest for the period of waiting, with the interest being taxed at ordinary rates.

The OpenStore way: "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 one to two month transition period, we pay the remaining 20% of the deal.

This schedule makes it fast & easy to move onto what's next vs. the performance-based earnouts that many other acquirers use." – Frank Kosarek, OpenStore.

Purchase price allocation and taxes

If you are selling business assets, you will need to become familiar with the new tax rules about allocating asset purchase prices, which took effect from July 1st, 2021.

The aim of these regulations is to stop taxpayers from allocating asset values in a way that gives them a more favorable tax outcome when buying and selling assets. The rules do this by incentivizing parties to a transaction to agree on values and follow these in 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.

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.

Both entities must also submit Form 8594, Asset Acquisition Statement, 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's total sale price and agree on how it will be allocated among seven distinct types of assets. The values are assigned using this allocation approach based on the market value of the assets at the time of the transaction. Follow these IRS guidelines for more information about purchase price allocation.

The OpenStore way: we actually prepare the asset allocation form for you shortly after close.

Business entity type and taxes

The type of business being sold also determines taxation protocol during a company purchase. Rules vary depending on if  the business is a single proprietorship, a partnership, an LLC, or a corporation.

The limited liability corporation is 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 as an S-corporation. As opposed to corporations, these business structures 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-corporation 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 companies are so protected from double taxes. They must, however, pay some taxes at the entity level if they have, for example, passive income.

Selling your Shopify store can be quick

Shopify stores have never been more appealing, whether they're built on drop shipping or proprietary supply chains.

If you run a Shopify store, selling it can be a great financial decision. The sale will enable you to reinvest your gain in a new venture, purchase a new home, or take time off before deciding what to do next.

However, you should understand the tax implications of your decision before you close the deal. A tax expert should help you understand some of the more complicated cases and develop a strategy for minimizing your tax liability.

OpenStore helps you eliminate many steps of the sales process, and gets you a free, no-obligation offer in 24 hours. Our in-house legal team prepares all the paperwork to aid in a simple process.

"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." – Frank Kosarek, OpenStore.

That’s all from us on taxation following the sale of your Shopify business–we hope you’re one step closer to making your decision. Get in touch with the OpenStore team to find out how you can easily and quickly sell your Shopify store.