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Are you considering selling your business but are concerned about the tax implications? If so, you might consider a structured installment sale. Here’s what you need to know about this option and potential tax advantages.
How Structured Installment Sales Work for Business Owners
Structured installment sales are one of several strategies for structuring insurance business sale deals. Under the Internal Revenue Code §453, the installment method of taxation allows a party who sells an appreciated asset to defer tax liability on the sale by receiving payment of the purchase price in installments. Under this method, the seller pays capital gains tax only on payments received in a tax year. Thus, a structured installment sale allows a business owner to spread capital gains taxes from the sale of their business over multiple years.
In a structured installment sale, sellers and buyers reduce risk by involving a bona fide third party. The buyer uses the purchase price to obtain an annuity from an insurance company and then assigns their obligation to make installment payments to the insurer. The insurance company then makes the scheduled payments to the seller, providing a guaranteed stream of income.
Key Benefits of Using a Structured Installment Sale When Selling a Business
Some of the benefits to owners of selling a business through a structured installment sale include:
- Deferred capital gains taxes: Structured installment sales leverage tax rules to spread out capital gains tax liability over multiple years.
- Elimination of the risk of buyer default: By having the buyer purchase an annuity from a reputable insurance company and assigning the payment obligations to the insurer, a seller can protect themselves against the risk that the buyer will later default on payments.
- Defined income stream: A business owner can enjoy a steady income stream from annuity payments, which may include both principal payments on the purchase price and interest payments.
Risks and Limitations to Consider Before Choosing a Structured Sale
Structured installment sales also have certain risks and limitations, including:
- No immediate liquidity: Selling a business through a structured installment sale means the business owner does not receive the cash infusion from the sale right away.
- Risk of insurer default: Although using an annuity from a highly rated insurance company provides more certainty that the seller will receive full payment for their business, insurance companies may still face a risk of insolvency or bankruptcy.
- No monetization of installment transactions: Sellers generally cannot borrow against or pledge future installment payments without risking adverse tax consequences or IRS scrutiny. Attempting to convert future payments into cash through such arrangements may undermine the tax-deferral benefits of the structured sale.
Legal and Financial Requirements for Setting Up a Structured Installment Sale
A structured installment sale has certain requirements, including that:
- The asset(s) being sold must qualify for installment sale tax treatment under IRC §453.
- The buyer and seller may need to execute documentation or disclosures from the insurance company providing the annuity.
- The buyer and seller must also formalize the transaction through an installment agreement attached to the sales contract, which outlines the payment schedule.
Contact Us to See If a Structured Installment Sale Is Right for You
You’ve worked hard during your career to build a successful business, and careful planning can help you make the most of the value you’ve created. Reach out to 453 Trust Powered by Pennington Law for a free consultation with an experienced attorney to explore how installment sale tax treatment could impact your capital gains tax from selling your business.
