Before you make a move: Tax implications when selling your business
Even successful, long-established business owners are prone to missteps when making decisions about divesting from their company, especially when those actions accompany a move out of state. Assumptions about how relocating to another state will lower your tax liability when you sell could have you running afoul of tax laws if you’re not careful.
Without a comprehensive understanding of both the tax laws in your current state and the new state you’re considering, you might overlook important factors regarding the structure of the sale, the timing of your move, and their impact on your tax liability. This article explores common misconceptions about tax implications when a business seller moves out of state and how to avoid tax on the sale of business assets.
Here are areas where common misconceptions arise about tax liability when a business seller moves out of state:
1. Rules about structured installment sales
When planning to move from a high-tax to a low-tax state, sellers might assume that structuring the sale as a structured installment sale, where payments are received over time rather than in a lump sum, will result in lower income taxes under the new state’s laws. However, states don’t automatically follow the federal tax treatment of deferring payments until cash is received.
Some states accelerate income recognition when you move out and stop filing taxes there, even if you haven’t received the cash yet under the installment plan terms. States like Massachusetts (AP 201) and Minnesota (Schedule M1AR) allow tax deferral if you remain a resident, but not if you cease filing after leaving. To maintain the benefits of a structured installment sale, you may need to file a form in your former state promising to continue filing tax returns there as long as you receive payments under the installment note.
Failing to do so could result in paying the full tax in advance, even without receiving the installment cash. It’s crucial to understand whether your current state recognizes deferral treatment when you move out. This knowledge could influence your decision to relocate, the timing of your move, or your choice to use the structured installment sale method.
2. Selling a partnership interest
If you moved from a high-tax state like California to a no-income-tax state like Florida and then sold intangible property such as corporate stock, the source of the gain for state individual income tax purposes is typically your state of residence at the time of sale. (This differs from tangible property like buildings or land, where gains are sourced to the property’s location at the time of sale.)
A potential pitfall arises with sales of partnership interests. Some states treat these as intangible sales, meaning that moving from California to Florida before selling the partnership interest would result in no state personal income taxation on the resulting gain.
However, other states take a “look-through” approach to sourcing the gain from partnership interest sales. For example, Idaho and Minnesota source the gain based on the percentage of the partnership’s operations conducted in the state. These states would tax a portion of your gain from selling an interest in a partnership that operated there, even if you sold your interest after moving away. The treatment of this issue is less clear in states like California.
Consulting with tax advisors familiar with the laws in both the state where the partnership operated and your new state of residence can help navigate these complexities.
3. Selling a business’s assets instead of selling an interest in a legal entity
Some business owners believe they can eliminate state income taxation on the sale gain by deferring the sale until after they move. However, because states can always tax nonresidents on income sourced there, it’s essential to consider how the sale structure may influence which state the gain is sourced to.
When selling tangible assets — a structure often preferred by buyers due to generous depreciation deductions — sellers are liable for income taxes on income sourced to all states where the assets are located, even if they don’t reside in those states at the time of sale. This applies regardless of whether the business is structured as an LLC, S corporation, C corporation, or sole proprietorship.
Additionally, sellers may need to collect sales tax on the sale of business assets like trucks, computers, and other equipment. While states may have “bulk sale” exemptions for sales of all or substantially all property of a trade or business, these exemptions (such as in California) can have “traps for the unwary” that, unless precisely followed, can add significant sales tax costs to the sale of business assets.
It’s crucial to remember that moving to a state with no individual income tax doesn’t exempt you from owing state income tax related to a post-move sale of business assets. The sale of business assets tax treatment can be complex and may involve issues like depreciation recapture and the allocation between capital assets and ordinary income.
4. Timing of move date and business sale
If you intend to sell your business in close proximity to when you move, that fact may work against your claim that you changed residences if you are audited.
For instance, if you sell a business for millions of dollars the day before claiming to move to a no-income-tax state like Florida, your former state is unlikely to accept that you stopped being domiciled there prior to the sale. While determining your domicile is based on intent, auditors can examine objective evidence — such as a major income transaction soon after a claimed break in domicile — to determine the seller’s actual intent.
Remember that states have access to various information about you — from bank accounts to car registration and license information to voting records — that can be used as evidence of when you actually intended to permanently move. A significant income transaction immediately after asserting a change in residency is more likely to trigger a residency audit of the tax years surrounding the transaction.
How Wipfli can help
Making decisions about your stake in a business as you prepare to divest, potentially leaving your historical domicile state, carries significant financial and tax ramifications. Well before you start packing, it’s wise to consult experienced tax advisors to help you understand the state and local tax (SALT) implications. Wipfli advisors can assist you in developing a tax planning strategy that maximizes your financial benefits, helps ensure legal compliance and still allows you to relocate to your desired destination.
Our team can guide you through the complexities of business capital gains tax, help you understand the tax rate for selling a business and explore strategies to minimize your tax burden. Whether you’re dealing with an asset sale, stock sale or considering a tax-free merger, we can provide insights on the most tax-efficient approach for your situation.
For more information, see our transaction advisory services web page, or continue reading:
