Whether you’re selling your small business or acquiring another company, the tax consequences can have a major impact on the transaction’s success or failure. Consider installment sales, for example. The sale of a small business might be structured as an installment sale if the buyer lacks sufficient cash or pays a contingent amount based on the business’s performance. Installment sales can sometimes — but not always — offer the seller tax advantages.

Installment sale advantages

An installment sale may make sense if the seller wishes to spread the gain over a number of years, as the sale is taxed as the sales proceeds are received. This could be especially beneficial if it would allow the seller to stay under the thresholds for triggering the 3.8% net investment income tax (NIIT) or the 20% long-term capital gains rate.

For 2016, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately) will owe NIIT on some or all of their investment income. And the 20% long-term capital gains rate kicks in when 2016 taxable income exceeds $415,050 for singles, $441,000 for heads of households and $466,950 for joint filers (half that for separate filers).

Installment sale disadvantages

But an installment sale can backfire on the seller. For example:

  • Depreciation recapture must be reported as gain in the year of sale, no matter how much cash the seller receives.
  • If tax rates increase, the overall tax could wind up being more.
  • If the buyer defaults on the installments, you may have to take back ownership of a business worth substantially less than on the day of sale due to mismanagement.

Please let us know if you’d like more information on installment sales — or other aspects of tax planning in mergers and acquisitions. Of course, tax consequences are only one of many important considerations.

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