After years of hard work, you finally built your business into something that others were clamoring to buy. You chose a buyer, settled on a price and closed the deal. Now you find yourself sitting on a big pile of cash with nothing to do. Where do you go from here?
Tax Ramifications of Selling a Business
The first thing you should do after selling your business is figure out your tax liability. How you are taxed will depend on two different things, the types of assets you sold and the structure of the business itself.
Types of Assets
To the IRS, your business is just a big collection of assets like real property, equipment, inventory and goodwill. Different kinds of assets are taxed differently. Upon sale, assets need to be classified for the IRS as capital assets, depreciable property used in the business, real property used in the business, or property held for sale to customers, such as inventory or stock in trade.
The Internal Revenue Code specifies that sellers and buyers must assign a specific value to each asset or group of similar assets and report a gain or loss from the sale of each to the IRS. Capital asset sales result in a capital gain or loss. The sale of real property or depreciable property used in the business and held longer than one year results in a gain or loss from a Section 1231 transaction. Inventory sales result in simple income or loss.
Sole proprietorships, partnerships, limited liability companies (LLCs). These three kinds of businesses are considered pass-through entities. Because of this, their owners enjoy a degree of flexibility in negotiating an asset sale, as all gains and losses pass through to the individual owners. (For related reading, see: Forms of Business Organization.)
C Corporations. C corporations can sell both assets and stocks, but assets are taxed twice. They are first taxed when the company pays the corporate tax rate on any gains realized from the sale of the assets. Then they are taxed again when their individual shareholders have to pay capital gains taxes on the distributions they receive from the liquidation of the corporation. When a C corporation sells its stock, the seller pays only capital gains taxes on the profit from the sale.
S Corporations. S corporations are taxed more like partnerships and so are able to avoid double taxation. They do not pay the corporate tax. Instead, the income or loss flows through to the shareholders, who include it on their personal tax return and pay taxes on it at the individual income tax rates. To avoid people gaming the system, the IRS rules state that a company must be an S corporation for a certain amount of time prior to the sale to qualify for all of the tax advantages. (For related reading, see: S Corp vs. LLC: Which Should I Choose?)
Using the Proceed From Selling Your Business
Once you’ve calculated your tax liability, you know what you have left to work with. While you may be tempted to throw it all into your next business venture, there is something else I think you should do first.
Grow a Money Tree Through Investing
First, I think you should plant a money tree. What is a money tree? It isn’t a new business venture, but rather something you plant and leave alone. Without your involvement, it will grow and produce fruit. I know that doesn’t sound like a lot of fun for an entrepreneur like you, but it can be a very wise move.
By putting 20% or so away, you can ensure that your retirement and future will be secure. I know what you’re thinking. You can get a much better return on your money through your entrepreneurial creativity and ingenuity than in the stock market. And you’re probably right. But what happens if you have an accident and no longer have the physical capacity to work? Or you have a stroke and your mind is no longer capable of that creativity and ingenuity? What then? (For related reading, see: How to Manage Entrepreneurial Risk.)
By setting aside some money to invest, you diversify your ways of earning money, instead of keeping all of your eggs in one basket. Then, you will be better prepared for the troubled waters that inevitably abound over the course of a lifetime.
Now to the fun part. Even if all you want to do right now is spend every day on the golf course, eventually you will get bored. It’s in your nature as an entrepreneur to be active and not sit idly by.
Once you’ve got your money tree planted, you can pour whatever you want into your next venture. And the best part is you know if things don’t work out, you’ve still got a comfortable cushion to fall back on. Wouldn’t it have been nice to have that the first time around?
(For more from this author, see: Commit to Saving Money to Transform Your Future.)