Tax Implications of Selling a Business by Entity Type

Selling a business has different tax consequences depending on the entity type. Here's a breakdown:

1. Sole Proprietorship

• Sale of Assets: The sale is treated as a sale of individual assets. The gain or loss is calculated by subtracting the adjusted basis of each asset from its selling price.
• Tax Treatment: Gains are reported on Schedule D for capital assets and on Form 4797 for other assets. Ordinary income rates apply to inventory, while capital gains rates apply to capital assets.

2. Partnership/LLC

• Sale of Interest vs. Sale of Assets:
• Sale of Interest: Each partner’s share of the partnership’s liabilities is included in the sale price. Gain or loss is calculated by comparing the sale price to the partner's outside basis (initial investment plus income, minus distributions).
• Sale of Assets: If the partnership sells its assets, gain or loss is determined at the partnership level and then passed through to the partners based on their ownership percentages.
• Tax Treatment: Capital gains apply to the sale of the partnership interest, while ordinary income may apply to the sale of "hot assets" like inventory or unrealized receivables.

3. C Corporation

• Stock Sale: The seller is taxed on the difference between the sale price and the adjusted basis in the stock, generally at capital gains rates.
• Asset Sale: The corporation pays tax on the sale of its assets. If proceeds are distributed to shareholders, a second layer of tax applies at the individual level on the difference between the distribution and the shareholder's basis in the stock.

4. S Corporation

• Stock Sale: Like a C Corporation, gain or loss is calculated on the sale price versus the shareholder’s basis in the stock, typically taxed at capital gains rates.
• Asset Sale: Gains and losses flow through to shareholders based on their ownership percentages. Shareholders may face both capital gains tax on appreciated assets and ordinary income tax on specific assets like inventory.

5. Calculating Gain/Loss

• Gain/Loss Calculation: For any entity type, the gain or loss from the sale is calculated as the difference between the sale price and the adjusted basis of the assets (or ownership interest).
• Adjusted Basis: This is the original purchase price plus improvements, minus depreciation or amortization.

Key Considerations:

• Allocation of Purchase Price: The allocation of the purchase price among different assets can significantly impact the tax treatment. For example, amounts allocated to inventory are taxed as ordinary income, while goodwill may be taxed at capital gains rates.
• Installment Sales: If the sale is structured as an installment sale, the seller may be able to defer recognition of some of the gain, spreading the tax liability over several years.
• Recapture of Depreciation: If assets have been depreciated, part of the gain may be subject to depreciation recapture, taxed at higher ordinary income rates.

Why Choose AJB & Associates CPAs?

Selling a business is complex, with significant tax implications that can affect your financial outcome. At AJB & Associates CPAs, we specialize in providing comprehensive tax planning and advice tailored to your unique situation. Whether you're selling a sole proprietorship, partnership, LLC, S Corporation, or C Corporation, our team will help you navigate the tax laws to maximize your gains and minimize your tax liabilities.

Visit ajbcpas.net to learn more about how we can assist with your business sale and tax planning needs.