Selling your business - a tool to reduce taxes on capital gains

"I'd rather expire at my desk to sell my business and pay Uncle Sam a dime in taxes." How many owners who have paid their fair share of taxes for twenty years of building their business feel this way? The tax bite is the single biggest factor in the reluctance of an owner sell his / her company.

I have written articles about various aspects of the structures to minimize transaction fees. As a result, I am often contacted by a salesperson in a panic, which is a week from the closing of its sale activities such as watching in disbelief at his accountant spreadsheet detailing the tax burden of its imminent sale.

Recently, the seller of a Sub Chapter S Corporation with a value of $ 8,000,000 transaction has contacted me. The taxable amount is below $ 200,000 and $ 4 million on the transaction value was the assumption of debt. When the dust settled, he was looking at a debt to capital gains of a staggering $ 965,000, while only receive the remainder of the proceeds, after the assumption of debt. The debt assumption is treated as part of the gain for tax purposes.

The owner sent his accountant paper for me and since I am not an accountant, I sent my tax wizard at BDO Seidman. He found a few small tweaks, but said there was not much that could be done by an accounting point of view for the owner. When I reported this back to the seller, I could feel his disappointment and frustration.

So I started my search for a better solution. After dozens of phone calls to my professional network, I was directed to a little known vehicle called a private annuity trusts. This vehicle has passed the examination of the IRS and the Tax Court. There is a way to avoid paying taxes, rather than a method to return with considerable economic benefit to the beneficiaries of the owner.

Here is a simplified description of the process. As the owner contemplates the sale of his company (or any highly appreciated asset for that matter) he "sells" to a trust prior to its final sale. This trust purchases the asset at FMV and exchanges an annuity payment stream complete with IRS life expectancy tables and interest rates. The trust then sells the company to the buyer to fund the annuity.

The operation was accompanied by a gift to the trust to the extent of 7% of the nominal value of the annuity. This is so it qualifies as a trust with the creation of an entity with economic value. Remember, the private annuity is considered as having an economic value equal to zero because the asset minus the obligation theoretically equals zero.

The trust is in the name of the owner and beneficiary of all aspects of the trust are controlled by the trustee / beneficiary and not by the owner. The trust for the benefit of the heirs owns the assets and has the obligation to pay rent. The trust can be structured to defer payments of rent for a period of time to coincide with the needs of the owner to receive such payments, say, for example, ten years during the ten years of investment trust or an annuity business to grow without incurring a tax bite for business sales.

When rents started, the owner is taxed to its then current tax rate for the portion of the fee income attributable to income from capital, its base (without VAT), and the depreciation recovered from the sale, and the income generated from rent . The annuity pays the spouse the owner and the payment of rent until the last to die, or until the investment of pension exhausted. If the die holder and the spouse, any remaining assets are transferred to beneficiaries outside of estate tax liability.

If your investments perform at the rate used in calculating the annuity and the last to die life to their life expectancy precise, theoretically the value of trust will be part of whatever gift (7% of sales) has grown to . However, if the investments very well and will survive the life expectancy tables, you can get paid well above the original face value of the annuity. Such excess payments would be taxed on the income tax rate then current.

If investments do well, and the value increases above the required amount of annuity reserves, the surplus can be distributed to beneficiaries as income.

In the simplest of points of view, this behaves as an IRA. There are currently taxed on the amount you put in, it grows tax deferred and you pay taxes upon distribution, hopefully at a much more favorable tax rate. In the case of the frustrated seller from above, what happens if you remitted all payments of ten years, the full sale price and $ 965 000 in capital gains taxes due? He had a life expectancy of 20 years after the start of distributions. The $ 965,000 that he paid in taxes increases by 7% to $ 1939.323000 for the time distributions begin.

Each annuity payment contains a portion of the gain or 1/20th of the total capital gain each year. Consequently, most of the investment value of the resulting gains deferral provides huge returns on capital for years to come.

If it sounds too good to be true, remember it is tax deferral and tax avoidance is not. The owner has sold his first company for the trust in exchange for a stream of annuity payments. The owner can not control the trust. To the extent that the owner wants immediate access to some of the proceeds of the sale, would pay all taxes in proportion to the amount he is receiving. In cases like the one above, this tax deferral tool can have a dramatic impact on the financial situation of the owner and his heirs, allowing the money to compound tax deferred for many years before their final delivery and payment of any tax ... ....