Want to Sell a California Small Business: How Much Tax I Need to Pay?
No California small business owner likes talking about taxes, and they certainly do not like paying them. However, that does not change the fact that taxes are a part of everyday life, especially in the commerce world.
Knowing the ins and outs of the tax code can be advantageous for small business owners, but a small business simply does not have the time to study and understand all these details. Your CPA or tax preparer may not have the time to give you the full picture of the amount of tax you have to pay as their skill is focused on preparing and filing tax returns to keep your California small business from attracting either an IRS audit, an audit by the Franchise Tax Board (FTB) if you are in California, the California Department of Tax and Fee Administration (CDTFA) if you collect and submit California sales tax, the Employment Development Department (EDD), or some other California State agency with the legal right to examine your financial statements. The stakes are higher still if you are a small business owner that is thinking about selling your small business in California.
As you may have guessed, there are taxes on selling a small business. That begs the question, if I sell my small business, how much tax will I pay?
Sell a Small Business in California, Now What?
When you sell your California small business, the buyer will typically bring cash down payment which you receive at the close of escrow when the transaction closes. If the buyer requires a third-party loan, this will be part of the escrow closing process and will be paid to you also when the transaction closes. Federal and state taxes are then due on that money in the year the business sale closes.
As the seller of the small business, if you provide any seller finance, the tax is not due and payable until you receive that money and in the year you receive it. For example, if you carry Seller Notes for 5 years and are paid every month, the tax is not due on that money until the buyer pays it to you and in the year you receive the money.
One of the requirements when closing the sale of a small business is for the seller and buyer to agree on the Purchase Price Allocation of the business. As the owner of the business, you have been allowed to write off business expenses for tax purposes; this includes being able to depreciate hard assets or, if you bought the business previously, get a tax benefit on the goodwill of the business you bought with a deduction called Amortization.
Now you are selling the business, the IRS wants the seller and buyer to negotiate and agree upon a tax structure that comes into effect when the sale of the small business closes. To report that agreed-upon tax structure, the IRS wants the seller and the buyer to each submit IRS tax form 8594 in the year the sale of the business closes. A seller and buyer can each complete this form themselves, but it is typical for the CPA for each party to assist them.
One of the things to know about selling a small business is that the Internal Revenue Service is not so much interested in the sale of your small business name but more so the value of your business assets.
Business assets include properties and tangible things of value that the IRS will want to collect tax on, and so the reason both the seller and the buyer have to separately complete and submit IRS form 8594. In theory, you could pay less in taxes by selling your small business name or stock, but the buyer will want to negotiate this with you as it may leave them in a poorer tax position.
Capital Gains Tax on Sale of California Small Business
Another thing you may have to look forward to is the capital gains tax on the sale of a small business, which brings us to capital gains tax strategies for selling a business. Without capital gains tax strategies for selling your business, you could pay the IRS and State of California a lot of the sale price of the business. Take this into account as part of your company exit planning before selling your small business.
When you sell a small business, you will most likely have to pay some portion of a capital gains tax. Capital gains refer to making a profit from an investment. In some cases, part of the capital gains tax sale of a business can be avoided or reduced.
The capital gains on selling a small business are reduced via deduction properly u structure your Definitive Purchase Agreement. How your Definitive Purchase Agreement is structured is key to learning how to avoid capital gains tax on business sales, but bear in mind what will be good for the seller is typically not good for the buyer, and so this is part of the negotiations when selling the small business in California.
Another thing to keep in mind is, in most cases, you will not have to pay 100% of your capital gains tax. Usually, people only have to pay around 50% on their capital gains. There are other strategies, though; we will explain these shortly.
Farms, fishing businesses, and small business corporation shares can qualify for a significant deduction on capital gains tax. For example, if you own and sell farmland with farm equipment, tractors, etc., you may qualify for a capital gains deduction that will exempt you from paying income tax on the sale.
How Is Goodwill Taxed When Selling a California Small Business
At this point, you might be asking yourself, how is goodwill taxed when selling a California small business? That’s a great question! The sale of small business goodwill tax treatment can play a major role in determining how much you will have to pay in taxes after selling a business.
Find out more about how goodwill tax works when selling a California medical practice.
When someone buys a business, it typically includes an item called goodwill. The typical method to calculate the amount of goodwill is to put a value on all the hard items, such as Fixtures, Furniture and Equipment, Inventory and Leasehold Improvements, then the soft items, such as Covenant Not to Compete and Training. Finally, simply allocate the balance of the purchase price to goodwill.
If the business’s goodwill is considered personal goodwill, it is taxed at an individual shareholder level, which means the rate is more favorable. However, if it is not considered personal goodwill, you could incur double taxation in which you are taxed at both the corporate level and individually. This also depends on the legal entity of the business, such as it being a C Corporation as opposed to an S Corporation or LLC, etc.
Managing the Tax Implications of Selling a Small Business
When it comes to managing the tax implications of selling a California small business, you could consult with a tax attorney or your CPA, or both.
Introducing Mr. Ed Cotney from Olympus Tax
While these tax professionals can definitely help you save some money, Rogerson Business Services would like to introduce you to Mr. Ed Cotney, who owns and operates Olympus Tax.
I’ve known Ed Cotney for about 8 years or so, and when I have a question about how I can save a California business owner some tax when selling their business, I always mention Ed Cotney and the service he provides.
Ed is an interesting guy as he has a funny accent. Well, it is probably not too funny if you were like Ed and came from Alabama.
One of Ed’s motivations in life is to help small business owners pay as little tax as they can when selling their small businesses in California. Ed offers to provide a consulting service to the business owner and provides a written report on his recommendations if the business owner chooses to hire him.
It will require the business owner to make decisions before selling the small business, if the buyer is willing to work with the seller or what is more normal, leaving the seller to execute some tax-saving strategies after the sale of the business closes.
Selling a small business does not necessarily mean that you will have to pay an arm and a leg in taxes. If you structure your sales contract properly, file everything promptly and appropriately with the IRS, and consult with a professional, you should be able to save a great deal of money.
One Final Tip
Be sure you do everything by the book. While you should take advantage of as many legal deductions you can get, make sure everything is reported fully and correctly so you can enjoy the gain you made from selling your business and the next phase of your life.
Want to learn more in an email tutorial program? Get started on a 7 steps tutorial guide showing you best practices in how to sell your California small business successfully. Link here: https://www.rogersonbusinessservices.com/sellingyourbusiness/