Finance and Accounting

Maximising tax efficiency in business exit strategies

Are you considering exiting your business or passing ownership? This should be an important question for business owners, even if an exit isn’t imminent. By planning early, you can explore different exit strategies that can make a significant difference in the financial outcome of your business exit. One aspect is exploring various tax-efficient strategies that can significantly reduce the tax impact of your exit and safeguard your financial legacy.

Planning for your business exit strategy

The sale and transfer of ownership of your business is perhaps one of the most critical components of a long-term plan because it entails several tax liabilities. Here are the tax planning strategies to consider –

Know your business structure

The structure of the company plays a significant role in your exit strategy. If you are the sole proprietor, you pay taxes on the profits. For example, if you made a profit of $200,000 on the sale, you pay an income tax or capital gains tax on the amount.

If you sell your ownership stake in a corporation, you may have to pay corporate as well as personal tax. Corporate taxes do not apply in an S corporation.

Consider a buy-sell agreement

A buy-sell agreement is relevant when you own the company with one or more partners. First, you need to know how much your shares are worth in case you want to sell the stake. The next step is knowing who is willing to buy your shares and how to fund the transaction.

It is common for people to fund this transaction through a life insurance policy, which is tax-free. Having a buy-sell agreement will reduce the risk of a dispute that you cannot solve outside the court.

Know the cost basis

The cost basis determines the profit you make by selling the business. For example, if you sell the company for $2 million and you spend $500,000 on supplies and equipment while you are the owner, your cost basis would be $1.5 million on which you owe capital gains tax.

Consider selling the assets separately

If you sell the company as a complete package, the price includes both outstanding assets and assets. This includes intangible assets such as brand value and goodwill. If you are the sole proprietor, selling assets separately may be a suitable exit strategy.

This way, you can have a regular income and spread the income or capital gains tax over a longer period.

Execute the exit strategy over several years

You can gradually shift the ownership of the business to a family member or key employee. By making regular gifts to employees and family members, you let them control the company gradually while reducing the value of your holdings to reduce the taxes.

As of 2023, the limit of gift tax exclusion in the U.S. was $17,000 per person per year.

Tax-efficient business exit strategies

Planning for the exit starts several years before the event happens. Tax strategies for selling a business require consultation from tax, legal, investment, and estate planning advisors. Let’s look at a few strategies and tips to consider.

Residency in a low-tax state

If you and your family are willing to relocate, setting up residency in a low-tax state is an option. You need to show your commitment as a resident of that state through voter and tax registration, driver’s license, and legal mailing address.

Grantor retained annuity trust (GRAT)

The grantor-retained annuity trust (GRAT) allows the owner to shift the business interest from the personal estate into a trust at a lower valuation. The trust’s value increases as the business grows.
When the trust ends, the beneficiaries can take ownership of the business without estate taxes. However, if the owner dies before the trust ends, the ownership returns to the estate, and the total value is subject to taxes.

Family limited partnership

A family limited partnership (FLP) is helpful if the owner wants to pass the ownership to other family members and reduce the associated gift and estate tax liability. After transferring the assets into the FLP, the owner maintains 99% interest in the limited partnership.

In addition to these, tax efficiency can differ significantly from country to country due to varying tax laws, regulations, and incentives. Maximising tax efficiency in business exit strategies involves a comprehensive understanding of these state and local tax laws, strategic planning, and the assistance of professional advisors. By considering the various options and planning ahead, business owners can significantly reduce their tax burden and maximise the financial benefits of their exit.

How can Infosys BPM help?

Working with a financial advisor can help you understand the concepts mentioned above and how they impact your current and future tax situation. With an expert group of tax advisors, Infosys BPM offers taxation services, leveraging AI and automation technology to assist in planning and executing business exit strategies.