BY ANDREW DICKENS, AIF®, CEXP™, CVBS™ DIRECTOR OF PENSION SERVICES &
WEALTH ADVISOR
Selling a business is often the culmination of years of hard work and strategic decision-making.
While a sale can result in a significant financial windfall, it can also trigger substantial capital
gains taxes, reducing the proceeds available to the seller. Fortunately, several strategies can be
employed to defer, reduce, or even eliminate capital gains taxes. In this article, we’ll explore the
most commonly used methods to help business owners retain more of their hard-earned wealth.
- Charitable contributions: Utilizing donor-advised funds (DAFs) and charitable
remainder trusts (CRTs)
One of the most effective ways to offset capital gains taxes is charitable giving. By donating a portion of your business interest before the sale, you can reduce taxable gains while supporting causes you care about.
- DAFs: A DAF allows you to donate part of your business interest to a charitable account
before the sale. Once transferred, the interest is sold by the DAF tax-free. This approach
enables you to avoid capital gains taxes on the donated portion and provides an immediate
charitable deduction equal to the fair market value of the gift. After the sale, you can direct funds to charities over time at your discretion. - CRTs: A CRT is used to transfer ownership of a portion of the business to a trust before the
sale. The CRT sells the interest without paying capital gains taxes and provides you (or another designated beneficiary) with an income stream for a set period. The remaining assets go to charity upon the trust’s termination. This strategy also offers an upfront charitable deduction based on the present value of the charitable remainder.
- Installment sales: Spreading the tax burden over time
An installment sale allows you to defer capital gains taxes by receiving payment for the
business over several years rather than in a lump sum. Instead of paying taxes on the entire
gain upfront, you report a portion of the gain each year as payments are received.
Key benefits:
- Spreads the tax liability over multiple years, potentially keeping you in a lower tax bracket
- Offers flexibility in structuring payments to align with your cash flow needs
Structured installment sales:
- They involve partnering with a large insurance company to back the payment schedule,
ensuring security and reliability for the seller. - Payments are guaranteed, providing peace of mind and reducing the risk of buyer default.
Considerations:
- This strategy works best when you trust the buyer’s ability to make future payments or utilize a structured agreement backed by a third party.
- Interest income on the installment payments is taxable as ordinary income.
- Opportunity zone investments: Reinvesting gains for long-term benefits
Established under the Tax Cuts and Jobs Act of 2017, opportunity zones allow business owners
to defer and potentially reduce capital gains taxes by reinvesting proceeds into a qualified
opportunity fund (QOF).
How it works:
- Capital gains from the sale of a business can be reinvested into a QOF within 180 days.
- Taxes on the original gain are deferred until the earlier of December 31, 2026, or when the
investment is sold. - If the QOF investment is held for at least 10 years, any additional gains from the QOF are tax-
free.
Best for:
- Sellers looking to diversify into new investments while deferring taxes
- Those who can commit to a long-term investment horizon
- Like-kind exchanges: Deferring gains with strategic reinvestment
While typically associated with real estate, Section 1031 of the Internal Revenue Code may also
apply to certain types of business assets. A like-kind exchange allows you to defer capital gains
taxes by reinvesting the proceeds into a similar property or assets.
Requirements:
- The replacement property must be of like-kind and acquired within strict timelines (typically
180 days). - All proceeds from the sale must be reinvested to fully defer the gain.
Limitations:
- Section 1031 is primarily limited to real estate transactions as of recent tax law changes.
- Employee stock ownership plans (ESOPs):
Selling to employees An ESOP provides a unique way to sell your business while deferring
capital gains taxes and rewarding employees. Under this structure, the business owner sells
their shares to an ESOP, a qualified retirement plan for employees.
Tax advantages:
- If the business is structured as a C corporation, the seller can defer capital gains taxes by
reinvesting proceeds into a qualified replacement property (a Section 1042 exchange). - The ESOP contributions to repay the loan used to purchase the shares are tax-deductible.
Best for:
- Business owners who want to transition ownership to employees
- Companies with strong cash flow to support the ESOP structure
Final thoughts
Deferring capital gains taxes on the sale of a business requires careful planning and execution.
The right strategy depends on factors such as the size of the sale, your long-term financial
goals, and your willingness to engage in charitable giving or reinvestment. Consulting with a
team of tax advisors, financial planners, and legal professionals is essential for navigating these
strategies effectively.
