How are gains from a business sale taxed?

November 07, 2024

by a searcher from University of Texas at Austin in Austin, TX, USA

Can someone please explain how taxes on the sale of an LLC works? I’ve heard the proceeds are taxed as ordinary income, but also that the goodwill is taxed as a capital gain?

Am I correct is saying that income means that on a multi-million dollar sale that you would be paying 35%-50% in taxes depending on the state?

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Reply by an investor
from The University of Chicago in Chicago, IL, USA

I would agree that the topic gets complicated - but in my experience, conceptual thoughts follow. LLC's with more than one member are taxed by default as a partnerships. The transaction most likely will be an asset sale. Gain / loss is recognized by comparing allocated sales value of an asset to its corresponding tax basis. The FMV of NWC, with rare exception, is the balance sheet carrying value (read: tax basis for an accrual basis taxpayer) and thus no gain as Mike Adhikari noted. From there sales value is allocated to prop & eq. but other than delivery vehicles and is some cases, machinery that is newer or more sophisticated (i.e. CNC controls) - the FMV of the prop & eq on a GAAP balance sheet is a moderate amount (save for a notably capital intensive business). Often the FMV here is near in magnitude to the balance sheet carrying value. Any gain here represents depreciation recapture and is taxed at ordinary rates. From there, the remaining sales value is assigned to the sale of goodwill which is taxed at cap gain rates. All-in, if structured correctly (and legitimately), the bulk of the gain is taxed at capital gains tax rates from a tax perspective - this is particularly true if the gain is significant (say an exit at 6X or beyond << a guess).

Reply by a searcher
from University of Greenwich in Toronto, ON, Canada

Thank you for reaching out with your question on the taxation of business sale proceeds.

This is a common question, and it’s great that you’re looking to understand the tax implications in advance. In general, proceeds from selling an LLC are subject to different types of taxes depending on the nature of the assets sold and the structure of the sale.

Certain items, such as inventory and accounts receivable, are typically taxed as ordinary income. On the other hand, long-term capital gains tax rates often apply to the sale of appreciated assets, like goodwill, which can result in a more favorable tax rate than ordinary income. However, the specifics can get quite complex, as various factors—like the exact nature of the sale, your ownership structure, and even state-level tax policies—can impact the final tax treatment. In multi-million dollar transactions, tax liabilities can indeed reach higher percentages, and careful planning can help manage the total amount owed. I'd be happy to discuss this in more depth to help you navigate the specifics of your situation and explore strategies to potentially minimize your tax liability.

Please let me know if you’d like to schedule a consultation to review your options.

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