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Dodging the Taxman
The IRS wants you to pay business-sale levies up front, but there are other options
As far as Mike Milligan is concerned, there has never been such an inappropriately named piece of legislation.
Milligan, CFO of Telenisus, a Rolling Meadows (Ill.) computer networking company, is talking about the 1999 Tax Relief Act. Signed into law last December, it contains a little-noticed provision that requires taxes on the proceeds of a business sale to be paid all at once, immediately--even if the funds are received in installments over several years. Relief? Not for Telenisus. It acquired two rivals in 1999 and was set to close on a third earlier this year until the new law stopped the deal in its tracks. "This has been the biggest headache we've had to deal with" since founding Telenisus in June, 1999, Milligan says.
The National Federation of Independent Business says the rule will change, stall, or scuttle about half of the 260,000 expected business sales this year. Maybe so. But entrepreneurs are a creative lot, and many are crafting ways around the law.
One option is to compromise--incorporating the cost of the tax into the sale price so the bill is shared by buyer and seller. That's what Milligan did in June, when Telenisus purchased A.S.K. DataCommunications, a Fairfield (N.J.) competitor, for an undisclosed price. The transaction originally was structured as a stock-and-asset deal with very little cash up front. To accommodate the tax change, Telenisus increased the cash portion of the deal, giving the seller enough funds to pay the tax bill. Milligan says the switch raised the purchase price nearly 20%, but it also enabled him to proceed with plans to expand into new East Coast markets.
Another strategy is to merge rather than sell. The buyer and seller form a partnership in which the buyer agrees to increase its stake each year, eventually taking over the business. Or you can sell on a contingent basis. The buyer's payments are contingent on the company's performance, and the seller isn't liable for taxes until the last payment is made and the deal is considered closed. One caveat: Both could raise red flags with the IRS, so be sure you have a competent attorney or accountant on board.
Finally, you can simply wait it out. Tiny businesses already got a break in late April, when the Treasury Dept. tweaked the rule to let businesses with annual gross receipts of under $1 million use the old pay-as-you're-paid method of accounting. New legislation to bump the limit to $5 million is on the table. Meanwhile, buyers might be wise to consider alternative growth strategies, while sellers may take some extra time to primp their business for the auction block. What are the chances for repeal? Click Online Extras at frontier.businessweek.comBy Sarah Rose