Ask HN: How do I minimize the taxes from selling my startup?
I'm about to sell my company. Because the company has existed for less than 1 year, I'm subject to short-term capital gains tax - about 35%.
The tax code stipulates that, if I invest the proceeds in a "qualifying small business" and leave it there for just a few more months, the proceeds of the original and the new investment are treated as long term capital gains - 20%.
Even better: if the proceeds stay in a QSB for more than 5 years, the whole thing is tax free, due to this: http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2010/CorpTax/TaxExclusion_Expanded.jsp
I'm fairly certain that there's a win/win/win here: a way I can use my proceeds to invest in a small business, create jobs (the goal of the tax break), make the economy better, but not take on the kind of risk that comes with a traditional tech startup angel investment. I've thought about buying a diversified portfolio of franchised businesses, for example, or creating a holding company that makes many small investments.
But I'm not a financial genius, there's always gotchas, and I don't want to re-invent the wheel. I've talked to two startup lawyers, a financial planner, and two CPAs, and while they can explain the mechanics, none of them have good suggestions about implementation.
Does anyone know of solid strategies for sheltering investment proceeds in a QSB without taking too much capital risk? This information would be really helpful to anyone here who successfully sells their company!
In this 2011 acquisition retrospective, @exitingfounder reflects on the journey of bootstrapping and successfully selling their business.
Hacker News peers debated transaction structures (cash vs earnout), founder tax strategies, and life after liquidating a long-term indie asset.
For legal advice, you apparently have money, so talk to the people who trade money for legal advice.
Are you positive that selling your company is the only mutually beneficial transaction you and the acquiring party can arrange? There are many possible options, with VASTLY different tax consequences but only minorly different changes on the ground. Stock sale != asset sale != IP licensing agreement != sudden decision of all key employees to change jobs.
Consider BobSoft, a hypothetical company with three engineers and some IP which is 100% owned by Bob. If BobSoft gets acquired by Google via Google buying all the shares from Bob, Bob has capital gains up the wazoo. If on the other hand Google buys all the assets of BobSoft, BobSoft continues to be a going concern. It continues paying Bob a salary for a few more months, puts around doing whatever BobSoft would do in the absence of their main line of business, hits the magic day on the calendar, and then buys all stock in itself back from Bob, who now has long-term capital gains. BobSoft then spins down in an orderly fashion.
Ask your competent legal advisers for how to work this such that you don't trigger the ire-RS. This is what they do.
More broadly: every tax cutout, no matter how well-intentioned, distorts the economy by paying smart people to spend more time figuring out how to hit the algorithm versus doing whatever they would otherwise do to earn money.
I've got bad news for you: that tax program expired in January. It was only a temporary extension to a small business incentive program that ran from 2009-2010. The law still exists, but the tax benefits are significantly reduced, and it only applies to C Corporations. (http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00001202----000-.html)
Here are some thoughts (for free, so not in enough detail to act upon without further legal advice):
- Hire a tax lawyer. The amount you save in taxes will pay for itself.
- If feasible, delay the execution of the sale until you have held your company for more than 1 year.
- Consider selling your company for stock of the acquiring company instead of for cash. The transaction would be fully tax free if solely for stock, and taxable only to the extent of cash/non-stock received. (See IRC 368, and related sections.)
- If you made the S election, you must unelect for Small Business Sale Exclusion to apply. This has fun tax consequences.
And finally, DO NOT HIRE A CPA to do this for you. CPAs know how to add things up, but they frequently get the law wrong. Tax lawyers exist largely to clean up the mess created by CPAs.
Don't forget state taxes - if you are an internet-based company and have no central office, there is really nothing keeping you bound to whatever state you live in. Look into moving the HQ to a state like Nevada - you can pay people to be a "registered agent" which means your business mail MUST go to that person and they'll forward it on to wherever you are.
Consider this "gray hat" tax advice. The tax code isn't built to handle companies without a true physical presence. They look to see where your main office is - if you don't have any, you can pretty much claim whatever state you choose. There may be rules about how long the HQ has to be in a state to qualify for the tax year, but I think that's it. Certainly ask your accountant/lawyer for more details and about the letter of the law here.
I have a good tax attorney, contact me if you want contact info. Here is one possible method. There is a company that will let you buy income insurance which you can then expense wholly (for the whole amount of the sale of your company). At some later date when you have additional expenses or take a loss or with other specific triggers, the insurance company will pay out your losses. You would typically do this in a year when you take a loss and the income from the insurance company balances the expenses for that year. They charge around 5-7%
This is basically a way to smooth out and balance taxes over multiple years.
I'm firmly in the camp of "pay for legal/CPA advice" rather than asking here.
But I've sort of been through this and the short answer is that the time to consider how you would minimize tax was when you formed the company.
Assigning the stock in the startup to a holding company you control vs personal ownership, getting into S-Corp vs LLC for the holding company, etc are all areas you could explore.
It's probably too late now, however.