subject: Selling Your Business - A Tool To Scale Back Capital Gains Taxes [print this page] "I'd rather expire at my desk than to sell my business and pay Uncle Sam one dime in taxes." How many house owners that have paid their truthful share of taxes for twenty years of building their business feel this means? The tax bite is the only biggest issue in an owner's reluctance to sell his/her company.
I have previously written articles discussing varied aspects of transaction structures to minimize taxes. As a result, I'm often contacted by a panicked seller that's per week from closing his business sale as he appearance in disbelief at his accountant's spreadsheet detailing the tax burden of his impending sale.
Recently, the seller of a Sub Chapter S Corporation with an $eight million transaction value contacted me. The tax basis was below $two hundred,000 and $four million of the transaction price was the belief of debt. When the dirt settled, he was looking at a capital gains tax liability of a staggering $965,000 whereas only receiving the remainder of proceeds after the belief of debt. The assumption of debt is considered as part of the capital gain for tax purposes.
The owner sent his accountant's spreadsheet to me and since I am not a tax accountant, I sent it to my tax wizard at BDO Seidman. He found a few small tweaks, but said that there was not abundant that might be done from an accounting standpoint for this owner. When I reported this back to the seller I could feel his disappointment and frustration.
So I started my quest for a higher solution. After several dozen phone calls to my professional network, I was directed to a very little known vehicle referred to as a Personal Annuity Trust. This vehicle has passed the scrutiny of the IRS and also the Tax Court. It's not a manner to avoid the payment of taxes, rather a method of deferring them with substantial economic profit to the owner's beneficiaries.
Below may be a simplified description of the process. Because the owner contemplates the sale of his business (or any highly appreciated asset for that matter) he "sells" it to a trust PRIOR to its ultimate 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 client to fund the annuity.
The transaction is accompanied by a present to the trust in the quantity of seven% of the face price of the annuity. This can be thus it qualifies as a trust by creating an entity with economic value. Keep in mind, the non-public annuity is viewed as having zero economic value as a result of the asset minus the duty theoretically equals zero.
The trust is during the name of the owner's beneficiaries and every one aspects of the trust are controlled by the trustees/beneficiaries and not by the owner. The trust for the advantage of the heirs owns the assets and owns the annuity payment obligation. The trust can be structured to defer the annuity payments for a amount of your time to coincide with the owner's want to receive these payments, shall we say, for example, 10 years Throughout those ten years the trust's investments or a business annuity grow without incurring a tax bite for the business sale.
When the annuity payments begin, the owner is taxed at his then current tax rate for the portion of the annuity payment owing to the capital gains, his basis (no tax), and depreciation recapture from the sale, and also the income produced from the annuity. The annuity pays the owner and spouse this annuity payment till last to die or till the annuity investments run out. If the owner and spouse die, any remaining assets are transferred to the beneficiaries outside of estate tax liability.
If your investments perform at the rate employed in the annuity calculation and the last to die lives to their exact life expectancy, theoretically the trust worth will be whatever the gift portion (seven% of the selling price) has grown to. But, if the investments do terribly well and you outlive the life expectancy tables, you'll receive payments well in excess of the original annuity face value. Those excess payments would be taxed at your then current income tax rate.
If the investments do well and the worth grows on top of the required annuity reserve quantity, the surplus can be distributed to the beneficiaries as income.
In the simplest of views, this acts like an IRA. You're not currently taxed on the amount you place in, it grows tax deferred and you pay taxes upon distribution, hopefully at a so much additional favorable tax rate. Within the case of the annoyed seller from higher than, what if he deferred all payments by 10 years on the complete sale worth and also the $965,000 in capital gain taxes owed? He had a life expectancy of 20 years beyond the beginning of the distributions. The $965,000 that he failed to pay in taxes grows at seven% to $one,939,323 by the point distributions start.
Every annuity payment contains a portion of the capital gain or one/20th of the full capital gain annually. Thus, the bulk of the ensuing investment price of the capital gains tax deferral provides huge returns for years to come.
If it looks too smart to be true, bear in mind it's tax deferral and not tax avoidance. The owner has sold his business initial to the trust in come back for an annuity payment stream. The owner cannot control the trust. To the extent that the owner desires immediate access to some of the sales proceeds, he would pay all taxes in proportion to the number he's receiving. In cases just like the one above, this tax deferral tool will have a dramatic impact on the financial standing of the owner and his heirs by permitting the tax deferred funds to compound for many years before their final distribution and therefore the payment of any tax.
