(TheStreet) - If you’re one of the millions of small business owners considering retirement within the next few years, think twice before agreeing to any early, unplanned sale. You could be leaving millions of dollars on the table.
There are tax consequences of a rushed sale, along with possible price discounts, you should consider before you entertain an early offer, especially an unsolicited one. This is especially true now as stock declines and recession worries have heightened fears that another bid won’t come along.
I’m seeing the rush already. Within the past year, four of the small business owners I’ve been working with decided to take early offers, instead of sticking with their original plan to sell within the next three to five years.
n the most egregious case, one will now pay more than $4 million in additional taxes on a $30 million sale. We had previously calculated that his taxes on a planned sale would be about $4.2 million; when he accelerated the sale, that tax burden more than doubled to roughly $9 million.
Here’s why he’ll face such a stunningly high tax bill: The rush means he doesn’t have time to convert his C corporation business to an S corporation as he’d originally planned. Without that conversion, the sale proceeds will now be double taxed: the C-corp will pay a corporate income tax on the asset sale, and my client will pay taxes on the liquidating dividend distribution. There are some planning opportunities he can utilize to further reduce the tax burden; however, he doesn’t like some of the features of the strategies and is likely to pass on them.
The COVID-19 Effect
Of course, it’s understandable if my clients and other small business owners are tempted to take the first offer they receive, even if unsolicited. COVID-19 changed the world. Employers and employees alike want to spend more time enjoying their lives outside of work. The shortage of qualified employees has made it harder to keep businesses running, prompting some owners to give up and retire sooner than planned.
At the same time, the stock market’s drop and recession worries have heightened fears that another bid won’t come along.
But an accelerated sales event can be extremely costly, and overly impact those who are planning to use proceeds from the sales of their businesses to finance their retirements. Baby boomers, the second largest age demographic in the U.S., account for roughly 21% of the population but own 41% of small businesses and franchises in the country, according to Guidant Financial, a consulting firm for small businesses.
A higher tax bill isn’t the only negative fallout from an unplanned business sale. Less preparation also means less time to clean up the books, strengthen balance sheets and reduce the amount of “hot assets” such as inventories, which are taxed at higher income tax rates instead of the lower capital gains rate. All these actions can help boost businesses’ valuations before a sale or increase the net amount received. Failing to take these actions risks attracting lower offers and a lower net payout.
Black Swan Event
It’s not just money and tax liabilities that business owners need to keep in mind when selling their businesses. There are also the unknowable factors, the black swan events, that no planning can foresee.
By Bruce Willey, CPA
December 14, 2022
