Taking over: What happens to your taxes when you're suddenly a business owner?
Whether you’re inheriting a family business or buying out a local business, suddenly becoming a business owner carries tax implications that affect your personal return. You’ll also now be responsible for the business’s tax obligations, which may include employment, state and local sales tax, and federal and state income taxes.
A tax lawyer or accountant can help you understand the financial documents offered in the sale. You’ll need access to local (if applicable), state, and federal tax returns. Tax issues and liabilities can pop up even years after a sale. Do your due diligence upfront and save time, worry, and money.
It’s not personal, talk to a professional
Even if you are taking on the family business, it’s probably time to call in a professional. The transfer or sale of a business can have vastly different effects for buyers and sellers depending upon how things are handled. For example, tax implications differ significantly for each side depending on how the business assets are categorized.
The seller will generally want to allocate most of their business’s purchase price to capital assets, which would be taxed as capital gains. On the other hand, a buyer would want the opposite because the ability to deduct depreciation of most of the assets transferred in the sale will help their taxes the most ultimately. In that one example, a buyer wants to claim more things that depreciate quickly, while the seller wants to claim the business has more assets that depreciate slowly. Both are trying to gain a tax advantage.
Add to the mix that the IRS has its own rules and regulations that govern how assets can and can’t be allocated, depreciated, and amortized. Even if the business is a simple transfer from parent to child, thanks to the IRS, it’s not as simple as handing over keys. You’ll want to bring in an expert to ensure everything is lined up correctly.
Stock or asset sale?
First, before delving into the tax history of the company you’re proposing to buy, consider whether the deal being offered is that of a stock sale or an asset sale. A stock sale is when you buy the seller’s shares of an existing corporation. An asset sale is when you buy the company’s assets and liabilities. There’s a lot to think about with both types of sales. The most significant things to watch for are tax issues and potential liabilities. For example, if there is an outstanding lawsuit, you could become liable as the business's new owner.
If the business you’re thinking of buying is a sole proprietorship or an LLC (limited liability company), you can’t structure your deal as a stock sale. These types of businesses don’t have stock. Owners of sole proprietorships or LLCs can sell partnership or membership interests. If the business is structured as a corporation (either S-corp or C-corp), the deal can be structured as either a stock or asset sale.
Each deal is different. Consult with a professional well-steeped in the purchases of businesses like the one you’re considering buying. Generally, an asset sale gives you more leeway as the buyer. An asset sale can benefit you as a purchaser by reducing the risk of hidden liabilities. But, when a stock sale is possible (if the company is incorporated), sellers often prefer a stock sale. There are tax benefits for them in this type of deal. Know your goals before entering into the deal.
Next, review the company’s financial history
The good news about buying a business is that most competently-run enterprises will have a paper trail. Their financial history is available for you to review. It may take some savvy to understand the current financial situation. Enlist the help of a tax professional or other advisor or attorney. Take a careful look at balance sheets and profit and loss statements. And it’s essential to delve into federal, state, and (if applicable) local tax returns. Look for outstanding tax burdens, liens, and other potential issues that could cause you headaches or unexpected expenses later on.
|Take a careful look at balance sheets and profit and loss statements. And it’s essential to delve into federal, state, and (if applicable) local tax returns.
Consider employment tax
Employment tax laws differ in every state, but a general rule of thumb is that employment taxes are deductible. This can be used to your advantage as the buyer if part of your deal to buy the business involves the owner staying on to train you for a period of time. Ask the seller to stay on for more wages as a way to reduce the business purchase price. In turn, this can lower your taxes on the acquisition of the business and give you tax benefits by paying taxes on the wages paid to the seller instead.
Another thing to look for relative to employment taxes when considering buying a business is to make sure that the company has been making all its employer contributions in a timely and complete manner. Outstanding payroll taxes can be a big headache, so be sure it’s not one you’re taking on inadvertently with your new acquisition.
Tax deductions for buying a business
IRS rules state that if you spend up to $50,000 to purchase a business, you can deduct $5,000 from your taxes. However, the benefits diminish on purchase prices over $50,000, going away completely after $55,000. Consider discussing ways of lowering the purchase price with the seller. This may ensure that you pay less tax. One technique is to hire the seller for a training period, transferring some of the purchase price to wages for the seller. Consider discussing seller financing of at least part of the purchase price for the business.
Consider pandemic-specific tax relief
Another thing to consider is whether the business you’re considering buying made sure to take all relevant credits and deductions allowed for businesses under the CARES Act. This pandemic-relief bill brought new tax opportunities for certain companies and the Employee Retention Act (ERTC). There may still be a chance to amend the business’s tax returns to take advantage of these savings. Consult a tax professional to determine if all relief has been sought. Ask if you’re in a position as the buyer to amend returns to ensure the business gets those tax credits.
Besides maximizing your tax benefits when structuring the purchase of your new business, once you’ve bought it, you’ll also want to stay on top of upcoming tax deadlines. Sign up for ComplYant for free. Never miss another tax deadline, and stay on top of important dates so you can avoid unnecessary penalties and fees.