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A few simple moves can save you millions in capital gains taxes when you sell your small- or medium-sized business.
So you’ve decided to sell your family business. You’re feeling great — maybe you have some initial interest from a buyer, or maybe you’re all ready to sign on the dotted line. Either way, if you’re like many of our users, you’re simultaneously celebrating the big win to come and thinking about how to keep more of your hard-earned gains for you and your family — that is, how to reduce your taxes on the sale. But how to sell your small business and avoid taxes at the same time?
We previously explained how you can use tax-advantaged accounts to reduce the capital gains taxes when you sell your business. We settled on Charitable Remainder Trusts (CRUTs) as a great vehicle for most people, because a CRUT can help you defer 100% of those taxes while earning meaningful annual distributions.
This time, we’ll take a look at common questions and pitfalls in the CRUT planning process for owners small- and medium-sized businesses. Here are the top three things to watch out for:
If you’ve spoken to us about Charitable Remainder Trusts, you’ve heard our common refrain. There aren’t a ton of constraints when setting up a CRUT, but there is one absolute requirement: To get favorable tax treatment, you have to place your assets into the trust before you sell them. Why? Because the trust is the tax-exempt entity in this transaction; like an IRA or 401(k), the trust will owe no taxes on the sale of any assets it holds. But that’s the key — the trust has to hold the assets. If, instead, you complete the sale before moving the assets into the trust, then the IRS will argue (reasonably) that you — not the trust — are on the hook for any taxes that accrue.
What does this mean in practice? There’s a long history of case law and regulatory rulings about when exactly you have to move your assets. What if you’ve hired a broker? Lined up a buyer? Received a letter of intent or term sheet? Signed a purchase agreement but haven’t closed? There’s no bright line, but, in general, the rule most lawyers and other trust experts follow is this: Move the assets as soon as you know you want to work with a trust, but, at the very minimum, do so before you are legally bound to sell — before you sign a purchase agreement or otherwise commit to selling.
Another common question, especially from owners of true small businesses, is whether you can transfer part of your business to a Charitable Remainder Trust while keeping a portion of it in your own possession. This is understandable: When you sell your business, you might want to hold some of the proceeds back for immediate needs — a home, your kids’ college fund, what have you — even if it means paying the associated capital gains taxes.
Good news: This is possible — and, in fact, very common. A trust behaves just like an individual in this context; if you transfer a portion of an asset to the trust, it becomes a shareholder. As long as ownership in the asset is divisible, that’s no problem.
When you set up your business, its corporate form is probably one of the first things you thought about. No wonder: There are dozens of options, and even among the top five it’s not always clear what’s best. And the data proves that out: A 2021 study revealed that about one-third of small businesses are set up as LLCs, a third are S Corps, and the remainder are a mix of C Corps, pass-through sole proprietorships, and partnerships).
How does your corporate form affect your access to tax planning? Here’s how to think about this question depending on your corporate status:
Nothing to worry about here. You can transfer some or all of your interest into a CRUT, and you’ll receive the tax benefits.
This one is slightly more complicated, but not insurmountable. A Charitable Remainder Trust cannot own S Corp stock, but that’s not really a barrier to entry, for a simple reason: When you transfer your stake in an S Corp to a CRUT, the business automatically converts to a C Corp.
That’s not a huge problem, but it does have some consequences.
As long as you keep these two caveats in mind, things are simple: Once you transfer the shares, your business is now a C Corp., and you can proceed with the sale — and receive the trust tax benefits — as if that had been true the whole time.
One last logistical question: If the trust now technically owns the business, how do you negotiate and close the sale? This one’s easy: Because you are (in most cases) the trustee, you’ll act on the trust’s behalf. There will be some formalities — when you sign the paperwork, it’ll be as trustee on behalf of the trust — but it won’t change the day-to-day negotiation and deal closing.
And that’s really all there is to it. The common issues are barely issues at all: You’ll simply decide what portion of your business you want to shield from capital gains taxes; consider the consequences of any conversion from S to C Corp.; and make sure that you move your business into your trust as early as possible, and definitely before you legally commit to selling.
Check out our Charitable Trust calculator to evaluate the potential return on investment given your situation, or contact us for a meeting!
We have built a platform to give everyone access to the tax planning tools of the ultra-rich like Mark Zuckerberg (Facebook founder), Phil Knight (Nike founder) and others. Valur makes it simple and seamless for our customers to utilize the tax advantaged structures that are otherwise expensive and inaccessible to build their wealth more efficiently. From picking the best strategy to taking care of all the setup and ongoing overhead, we make take care of it and make it easy.