Selling Your Business? Understand the Tax Implications First

Selling your business is more than just signing on the dotted line—it’s a financial milestone that can either set you up for long-term success or leave you with an unexpected tax bill. Without careful planning, taxes can take a bigger than anticipated bite out of your proceeds.

From structuring the sale to optimizing tax treatments, every decision plays a role in how much you ultimately take home. Whether you’re selling to a competitor, passing the business to family, or facilitating a management buyout, understanding tax implications is crucial. This guide breaks down key considerations, common oversights, and tax-saving strategies—including those unique to California—to help you navigate the process with confidence.

Define Your Sale Objective

Your sale objective shapes how you structure the transaction. Different goals require distinct strategies:

Understand Your Business Entity Structure

The structure of your business plays a role in determining tax liabilities upon sale; optimizing the entity structure in advance can lead to substantial tax savings. In some cases, restructuring your entity in advance can create better opportunities for both sellers and buyers. This is something you can explore with your CPA to optimize your tax outcome.

C-Corporation: Faces double taxation—once at the corporate level and again at the shareholder level upon distribution. Owners should consider whether an asset sale or a stock sale provides the best tax outcome. Buyers typically prefer asset sales to claim depreciation benefits, but sellers may benefit from a stock sale to reduce tax exposure.

S-Corporation: Pass-through taxation allows for certain tax advantages, but the allocation of sale proceeds between goodwill, business assets, and consulting agreements should be carefully planned to optimize tax treatment. Proper restructuring, such as an F-reorganization before the sale, can improve the tax efficiency of a deal.

Partnership or LLC: These entities provide pass-through taxation, which can help reduce overall tax liability. To minimize tax liability, sellers should structure their gains to be treated as capital gains instead of ordinary income, which is typically subject to higher tax rates.

Four Tax-Efficient Strategies to Consider

When selling a business, careful tax planning can help maximize after-tax proceeds and reduce unnecessary liabilities. Several strategies can be employed to optimize the tax impact of the sale.

1. Utilize a pass-through entity tax deduction, which may be available at the state level for owners of S Corporations and LLCs. A pass-through deduction can reduce federal taxable gains and provide substantial tax savings.
2. Consider allocating part of the sale price to personal goodwill. Since personal goodwill is linked to the seller’s reputation and relationships rather than business assets, it is often taxed at lower capital gains rates than ordinary income.
3. Structure a portion of the proceeds as tax-deferred income. Sellers who receive payments through a retirement plan or consulting agreement can lower their immediate tax liability by spreading income over multiple years.
4. For business owners who also own the real estate used by their company, consider leasing the property to the buyer, thus generating ongoing income. Owners who have real estate partners may want to separate property pre-sale to enable tax strategies like a 1031 exchange. Consider utilizing a 1031 exchange to reinvest in new property and defer taxes on real estate gains. Read more about 1031 exchanges in our article on Understanding California’s Rules for 1031 Exchanges: What Real Estate Investors Need to Know, by Kathaleen De Salles, CPA.

Common Pitfalls in Business Sales

Mistakes in the business sale process can lead to unnecessary tax burdens, missed financial opportunities, and complications for both buyers and sellers. Understanding these common pitfalls can help business owners take the proper steps to avoid costly errors.

• Misallocation of Purchase Price: Improper allocation between goodwill, tangible assets, and other categories can result in excessive tax burdens. Proper tax planning ensures the most favorable breakdown.
• Timing of Business Closure: Failing to close the corporation in a timely manner may result in shareholders having an unused stock basis, which can lead to an unutilized capital loss and lost tax benefits.
• Failure to Optimize Entity Structure: Plan business transitions in time to consider restructuring the entity before a sale to produce substantial tax savings
• Incomplete or Inaccurate Financial Records: Engage a CPA to clean up financial statements before listing the business for sale is essential. Poor financial record-keeping can reduce the perceived value of the business and deter potential buyers
• California-Specific Tax Considerations: Ponder your location. Business sales in California are particularly complex due to the state’s high tax rates and strict regulations. One potential tax-saving strategy for S Corporations is the Pass-Through Entity Tax Election (PTET), which enables business owners to pay state taxes at the entity level and claim a federal deduction. Additionally, some business owners may consider moving out of California to reduce their tax burden. However, achieving non-residency status for tax purposes takes time, often requiring several years before any tax savings can be realized.

Strategic Planning for a Business Sale

Selling a business requires careful planning to maximize value and minimize taxes. Engaging a CPA at least two years in advance can improve financial records and identify tax-saving opportunities. If restructuring your entity offers benefits, early action is key.

A well-structured sale requires expertise in legal, financial, and tax matters. Working with a CPA, attorney, and financial advisor ensures compliance and maximizes after-tax proceeds. If you’re considering a sale, consult Grimbleby Coleman to develop a tax-efficient strategy tailored to your goals.