When selling a business, it’s critical to consider the tax consequences. After all, you’re selling what likely is your biggest asset. If you plan to retire post-sale, smart tax planning can be especially important, because you likely are depending on the sale proceeds to fund your retirement. One option to help mitigate potentially negative tax consequences is an installment sale.

How It Works

In an installment sale, you transfer your ownership interests in exchange for a promissory note and receive at least one payment after the tax year of the sale. This allows you to spread your gain from the sale over multiple years.

This, in turn, defers taxes, which typically is beneficial. In some situations, it could even permanently save taxes, such as if receiving installment payments instead of a lump sum payment keeps you from being pushed into a higher income tax bracket or from being subject to the 3.8% net investment income tax.

Other Benefits

Installment sales also have nontax benefits. For example, you receive interest payments on the promissory note over the installment period. This might even be at a higher interest rate than you could earn from other types of investments.

An installment sale also can benefit the buyer, and thus help you close a deal. What’s the appeal for buyers? If a buyer doesn’t have sufficient cash, an installment sale can allow the buyer to fund the deal without having to seek outside financing.

Finally, if you and the buyer are having trouble agreeing on a price, an installment sale can be structured so that the buyer pays an additional amount contingent on the business’s post-sale performance. This might allow you to get a price you couldn’t otherwise get due to buyer worries that the business will not perform up to expectations.

Potential Downsides

An installment sale isn’t without potential downsides, however. For one thing, depreciation recapture must be reported as gain in the year of sale, even if the cash you receive in that year is less than the recapture amount. There’s also the risk of a tax rate increase, which could cause your total tax liability to increase in future years when you receive the cash.

Professional Advice

The rules surrounding installment sales are a bit complicated. And there are many important considerations beyond the tax consequences that you must consider when selling your business. That’s why professional advice is essential.

We have the experience and expertise to advise you on both the tax and the nontax aspects of selling your business. Please contact us if you have questions about installment sales or would like assistance with other aspects of selling your business.