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Consider the Installment Method When Selling a Small Business

Reporting the sale of your small business using the installment method can save significant amounts of federal income tax, and can provide flexibility to both seller and buyer.

An installment sale can save tax dollars. Each year, over 250,000 businesses are sold using an installment sale of assets, where the buyer pays all or part of the purchase price in installments over several years.

By using an installment sales you can spread at least part of the tax otherwise due on the sale of your business assets over the same period you receive payments.

Any tax due on depreciation recapture or sale of ordinary income-producing assets must be paid currently, and you should be sure to get enough “cash up front” to at least pay that tax liability. The installment method is attractive because it allows your income tax liability on gain from the sale of assets that produce capital gain, such as goodwill and land, to be paid as you receive the sales proceeds.

Ideal prospects for an installment sale are owner-managed businesses with less than $10 million in annual revenues. Buyers of such businesses typically can’t get full financing from the capital markets, and they want to acquire assets, not stock. Larger businesses rarely use the installment method, because they can get financing, and they more often acquire stock instead of assets.

Stock acquisitions require extensive due diligence. If you buy stock, you inherit the seller’s tax liabilities for prior years, environmental liabilities, and a number of other possibly devastating non-financial exposures. Asset acquisitions are usually less complex.

An asset acquisition also may have significant tax benefits for the buyer. A purchaser of assets records the price paid for them as their tax basis for purposes of claiming depreciation and amortization. The installment method allows the buyer to begin realizing the benefits of increased depreciation and amortization deductions before the entire purchase price is paid — using money not paid in taxes to pay part of the installment payments.

A few other points to remember about an installment sale.

  1. It will open up you sale to more potential buyers
  2. You do run the risk of the buyer defaulting. In this case you can never be sure of what condition the business will be in if you have to take possession again
  3. Future tax rates on the sale are never certain.

We have experience helping both buyers and sellers secure maximum tax advantage when transferring ownership of closely held businesses. Give us a call and arrange a time to discuss your plans. We will be happy to share any money-saving ideas we may have with you.