AMA Recap: Effective Strategies for Legally Mitigating Your Tax Bill

Are you an entrepreneur scaling your online business for an eventual sale but are worried about your tax liabilitiy? The time to begin planning for a deal structure that could reduce or even eliminate your tax burden is now.

 

Tax expert Shanyn Stewart joins Quiet Light founder and M&A leader Mark Daoust to discuss a wide array of the most common questions entrepreneurs have regarding taxes. Shanyn and Mark share real tips and strategies for deal structures and accounting methods that are really legal and will really lessen your tax bill.

 

You’re going to learn:

• The truth about how capital gains tax really works
• How to balance mitigating your tax bill and demonstrating high SDE
• How to structure a deal so you pay less tax
• The difference between basis and expense
• How to plan for a profitable exit
• How knowledge is your biggest weapon in tax planning

TRANSCRIPT

**Christopher:** Let’s get this show on the road. I’m so happy to have you all along with us. My name is Christopher Moore. I’m the Chief Marketing Officer of Quiet Light. I do all things digital content and marketing, that sort of thing.

I’m very happy to be part of this AMA. We’ve been doing these AMAs and webinars throughout the fall. We’ve been very happy with how they’ve come along, and we want to continue to provide content like this. So, we hope that you find it useful and enjoyable as well.

If you don’t know, Quiet Light helps entrepreneurs build, buy, and sell their businesses for six, seven, or eight figures. A big part of what we do is educational. We speak at conferences, we do virtual events and webinars, and we even have some social events and stuff like that.

We do a lot of writing. We put together coursework. We just re-released a course that Mark did on our website, and I’m very happy to share that.

Really, what we want to do is help founders and entrepreneurs, whether it’s e-commerce, SaaS, or content, identify and reach their exit goals—to treat their online business as their most powerful asset and an engine for them to achieve their financial goals.

Obviously, there are big tax implications with that, which is why we’re talking today.

We, as a company, were founded in 2006. Right, Mark? Or 2007?

**Mark:** 2006, but it was at the very tail end of 2006.

**Christopher:** We are entrepreneur-led and entrepreneur-focused. We’re going to talk a little bit more about that in a moment.

But enough about Quiet Light and myself. I want to talk about our two wonderful speakers for this AMA.

First is Shannon Stewart. Say hi, Shannon.

**Shannon:** Hello.

**Christopher:** Shannon is the founder and master of all things, I would like to say, at Advanced Accounting Solutions. She founded that company—can I say 25 years ago?

She is terrific and a very knowledgeable tax and accounting person. She holds Series 6, Series 7, Series 63, and Series 65 licenses. She’s the author of *The 10 Most Expensive Tax Mistakes That Cost Business Owners Thousands*. She’s a Certified Senior Advisor and Certified Acceptance Agent with the IRS, and she received her designation as a Certified Tax Master, which is an awesome title, in 2017.

I’ve always wanted to be a master of whiskey, but no one’s offering me that title.

So, thank you for being here, Shannon. We’re so happy to have you.

Our other panelist is Mark Daoust. Mark is the founder and grand poobah, keeper of the keys, keeper of the vision at Quiet Light.

Like all Quiet Light advisors, Mark has built, bought, and sold several online businesses. Do you know the number, Mark, of businesses you’ve owned? Legit businesses, not just domain names you bought.

**Mark:** Well, I mean, going down the domain names is more interesting because you see all the crazy ideas and you’re like, “What was I thinking? Was I drinking when I registered that?” No, I wasn’t.

As far as businesses that actually had some legs, probably about six or seven. I don’t know offhand.

**Christopher:** Some sort of legs. That’s good.

All of our advisors—I think actually 10 of the 11—have built, bought, and sold. One has only done a couple of those things, so definitely the junior person on the totem pole. But Mark is no exception there.

He’s a sought-after speaker, has authored articles for *Inc.*, *Forbes*, *BuzzFeed*, and *Entrepreneur* magazine. And although he couldn’t get into Harvard, his thoughts and concepts are taught there. We’re very happy to have him with us as well.

I think that’s the ultimate revenge, to be like, “Yeah, you wouldn’t take me, but you will teach me.”

**Mark:** That’s right. My thoughts.

**Christopher:** So, thank you, Mark and Shannon, for being here.

Of course, this is our AMA webinar on effective strategies to mitigate your tax bill, something really important that all entrepreneurs want to know a lot about.

Again, if you have questions that you want to ask, drop them in the Q&A box or into the chat window. We’re happy to have them there.

Our first question is just a joking question from one of our colleagues, Joe. He says, “Is flannel the required Quiet Light uniform?”

That is certainly not true. I’m not even wearing flannel, just plaid. But it is a cold day. I’m in Boston today. I’m from Denver, and it’s a cold day here in Boston. But, yeah, it’s not a required uniform whatsoever.

**Mark:** Because I didn’t get the memo, right? I’m only wearing it because it’s snowing today here in Minnesota, so it just makes sense.

**Christopher:** Great. So, let’s just jump right into it here.

Again, if you’d like to ask a question, feel free to drop it in the Q&A or into the chat window. We’ll get to those in the order that they’re received.

But I want to start off with a very general question, and it’s directed at both of you, especially since at Quiet Light we help entrepreneurs exit their businesses.

How much should people plan on paying in taxes when they sell their online business?

Shannon, I’m going to say you, since you’re the Certified Tax Master, the black belt of the tax world. I want to hear you kick us off on that, if you could.

**Shannon:** Well, I think one of the things I wanted to mention as I start to work with people—I’m an Enrolled Agent as well, which is actually something you don’t hear about as often as CPAs.

Enrolled Agents are the only federally licensed tax professionals in our country. We’re licensed right through the Treasury Department, and we are America’s tax experts. So, if you run across an Enrolled Agent, you know that you have a tax expert as you’re looking at the different tax professionals.

But when we’re talking about how much should you pay in taxes, the least amount legally possible is always my answer.

There are many caveats within the IRS code that actually allow us to legally mitigate your taxes on the sale of a business, and most people don’t even know that.

**Mark:** Shannon, do you know how many pages the tax code is?

**Shannon:** Well, the first nine define income, and every other page after that is all about a web of exceptions and preferences and so forth.

It’s changing. It changes every year. However, there are some tried-and-true things that never really go away because those that understand the code are not going to actually erase the things that benefit them the most.

A lot of the concepts that we actually employ have been around for 100 years. Installment sales, those types of things, have been in the code for years and years and years. They’re not going anywhere—knock on wood—because they help those individuals that are buying and selling businesses on a huge corporate level as well.

But it doesn’t matter the size of your company that you’re selling. You can use these strategies.

**Mark:** If somebody doesn’t use these strategies—Shannon, Chris, I’m going to jump in with a question here.

I’ve heard that before too, which is why I asked. The first nine pages are what you owe in taxes, and the rest of the tens of thousands are how to not pay those taxes. I mean, it’s funny, but it’s also true.

But if somebody doesn’t employ tax mitigation strategies and they have an S corp set up, what’s a typical expectation? Where’s our bar here that we’re hopefully going to reduce with strategies?

**Shannon:** Best-case scenario, it’s just capital gains and your state tax.

But if you have depreciation and you have to recapture depreciation, that’s ordinary income. So, right now, 37%.

When I’m looking at someone and they’re coming to me from a standpoint of no planning whatsoever, you’re going to lose 40% to 45% off the top.

If you’re in California or New York, you’re more like 50% to 55%.

**Mark:** Is that depreciation just on—like, if you purchased a business and you’re depreciating that purchase price—or is it on equipment purchases?

**Shannon:** Everything. Everything in the business.

So, it’s anything that’s depreciated as far as equipment, buildings, those types of things that are on the depreciation schedule.

What I always tell individuals is: Pull your tax return, look at your depreciation schedule, and see what your accumulated depreciation has been for the life of your business. That’s going to have to be recaptured at ordinary income tax.

Most people—the deal looks really good on paper because they’re thinking, “Well, I’m just going to sell, and it’s just capital gains. No big deal.”

Then when they start to say, “Okay, now I’ve got to look at depreciation, and I’ve got to look at my state tax,” and if you’re in New York City, you’re looking at New York City tax. You have all of these moving components.

Sometimes a deal will look really good on paper, but when you start to add in taxes without planning, it doesn’t really make sense.

**Mark:** Right. That’s fascinating.

The recapture depreciation is an interesting aspect of it, for sure.

At Quiet Light, most of the deals that we do are asset sales, and we typically have those allocated 100% toward goodwill or toward long-term capital gains tax treatment.

So, you’re looking at what for that? You’re looking at 20%, 22%, in that range?

**Shannon:** At the federal level only, not necessarily at the state level.

Usually, because we don’t have buildings or typically equipment, we don’t have a lot of the depreciation. But there are still depreciation schedules.

If you have, like, $100,000 of accumulated depreciation, you’re paying ordinary income on that.

Here’s the thing that I find a lot of entrepreneurs do: They depreciate their cars. That’s a huge one.

If you buy a car every three years and you’ve been in business 25 years, how much depreciation do you have? Those things add up.

One of the things I also want to mention—and you mentioned this—is allocating toward goodwill.

One of the strategies that we use in our planning technique is we can only defer the taxation on what is actually classified as goodwill.

So, as you structure the sale, it’s really important how you allocate those assets in the sale.

**Mark:** Let’s jump into the allocation of the purchase price, unless there are any open questions out there, which I’m not seeing at this point.

I think this is a document that’s really important to understand, both on the buy side and on the sell side. It’s a key piece to most purchase agreements.

At Quiet Light, in our templates and everything that we do, it typically is one of the exhibits. The allocation of the purchase price is basically saying the buyer is going to send over a million dollars, and we’re going to divvy that million dollars up to these different assets within the business.

It can be the domain name, source code, content, and then this very murky concept, for most of us who don’t live in your world, Shannon, of goodwill.

Can you explain the asset allocation agreement? Where does that actually come home to roost for the buyer and the seller? When does that document become, “Oh, this was a really important document in this process”?

And then, once we get through that, barring any more pressing questions, I’d love to get into strategies on both the buy and sell side for that document.

**Shannon:** What I like about Quiet Light is you actually talk about it and bring it to the forefront, and it’s in your exhibits.

Oftentimes, when we’re going through the process of a sale with a client, it’s the last thing people think about.

We went through a deal recently. It was a software company, and it was like a $150 million deal. It closed, and we still didn’t have a finalized allocation.

**Mark:** Are you kidding me?

My first sale, when I exited my first company, the moment that I learned about an asset allocation was when I brought it to my tax professional.

She said, “Okay, well, how is this allocated?”

And I said, “What do you mean?”

“You have to know how it’s allocated, and you and the buyer need to agree on this.”

**Shannon:** Yes. It was something that their due diligence team really was not focused on.

So, it’s really important to understand the allocation. For instance, when I’m looking at the allocation, the first thing I want to do is: What can I put toward goodwill?

That’s really what we’re looking at with the allocation.

Now, there are going to be certain situations where there’s not a lot of wiggle room for different reasons. However, the more that I put toward goodwill, the more planning strategies I have to actually eliminate or defer those taxes in the future.

**Mark:** Awesome.

It’s a consideration that should be talked about during due diligence. In my mind, that’s where it should be. It should be something that is really discussed and brought to light so that it’s fair for both the buyer and the seller.

What are some elements in that? We have goodwill that we can allocate toward. What about a non-compete? I’ve seen allocations toward non-compete. Is that taxed as ordinary income, or is that also capital gains?

**Shannon:** That would be capital gains.

Now, again, on the tax strategy, let’s say, for instance, you’re selling your company and we want to defer taxes. I would look at that non-compete clause from the standpoint of, if I am going to receive a monetary value for that non-compete clause, then that means that I can’t defer those taxes. I’m going to have to absorb them at the day of sale.

So, from that standpoint, that allocation becomes very important.

Maybe it’s only 1%, 2%, or 3% of the overall deal, but that’s where all of these little nuances become so critical.

**Mark:** Right.

**Christopher:** We do have a question. Thanks, Main, for sending this question.

He has an Amazon PL business, all inventory, no other assets. He’s had the business for years. On a sale, would the proceeds be taxed as long-term capital gains, 15%, or ordinary income?

**Mark:** This is right back to our question, right?

Shannon, it’s how you allocate it. And first of all, long-term capital gains—correct me if I’m wrong, Shannon—15% was what we had six or seven years ago. It’s no longer, right?

**Shannon:** Correct. We’re at 20% capital gains under the current tax code. Then, of course, that’s just federal. Then you have state and local.

**Mark:** I’ve seen some at 22% or 22.5%. Am I thinking a little old here with that?

**Shannon:** Here’s the situation. From the standpoint of the overall sale, the net effect is usually going to be around 20%. It can be higher.

Especially if you’re over $250,000, then you’re going to have an additional 3.9% factored in there as well.

**Mark:** An additional 3.9%. And then your personal income impacts your capital gains?

**Shannon:** Correct. Exactly.

We can have zero, 10%, 20%. No one selling their business is going to not pay any type of capital gains. The average is going to be about 20%.

**Mark:** Okay. That’s helpful.

Hopefully, people understand here, answering the question that we opened up with, Chris, it’s a loaded question, right? “How much am I going to pay when I sell my business?”

I don’t know. It depends on a lot.

So, Main, for your question as to how much you’re going to be paying, most Amazon FBA businesses that we sell are going to be taxed at long-term capital gains tax rates, from what we see, assuming that there are no additional strategies to mitigate that.

Where the effort and the work are going to be done is in that asset allocation agreement.

I know Joe Valley, my business partner, makes a point to have that negotiated even all the way up to the LOI portion, so before we get to the purchase agreement level.

That’s because the tax treatment for the buyer and the seller doesn’t necessarily always agree.

A buyer might look at this and say, “I want a different allocation for this because I want to have a more favorable tax situation,” but that has a negative impact on the seller.

Shannon, are you able to comment on that a little bit on the buy side?

My understanding is, if you buy a business for a million dollars, you can depreciate that over—is it 15 years? Is that the depreciation schedule?

But there are also ways to maybe expense part of that purchase price rather than depreciate it—expense it right away or maybe over the first few years. Am I off base on that?

**Shannon:** You’re correct from that standpoint.

We’re always looking for fair and equitable on both the buy side and the sell side.

**Mark:** We very rarely see stock sales go through, right?

**Shannon:** Right.

**Mark:** I’m assuming that’s what you see as well. They’re mostly asset sales because that’s what’s better for—

**Shannon:** Yeah.

**Mark:** Absolutely. Most buyers don’t want to do stock sales because of the liability, taking on the liability of the company.

But let me bring up a real scenario for you that somebody tried to do. I looked at it and said, “Guys, this smells bad. I would contact a tax professional about this.”

It was allocating part of the purchase price to software.

By doing it to software, the buyer said, “It’s like I’m buying software. I don’t depreciate my software purchases. I expense them right away.”

And the seller is saying, “I built this software, and I’m selling this as the asset that I built, so therefore I have long-term capital gains.”

Again, just so everyone follows, the buyer is looking to say, “I’m buying the software for a million dollars. This company is making $300,000 a year. I’m going to carry a loss of $600,000 in that first year because I made this mega purchase, and I get to carry that loss forward for the next several years.”

They get a really favorable tax situation, and the seller is happy because they get long-term capital gains.

And you’re shaking your head saying somebody’s going to jail.

**Shannon:** That’s a great one.

I do tax resolution. Those are the kind of people who knock on my door who are now being audited, and now I have to defend that position through tax court.

That is something that, from that standpoint, would be a no-no.

I think any tax professional would be saying that’s not legitimate. Software is not an expense that we can just write off and carry forward losses on. It is going to be the asset of the business. That is the business, because without the software, where is the business?

**Mark:** Yeah, I would agree.

I don’t want to go down the rabbit hole because we’re talking about selling businesses, but when does buying software become something that is expensed versus depreciated?

**Shannon:** I’ll give you an example. I have an accounting firm, and I buy tax software every single year. It’s renewed every single year. That’s an expense.

I’m not a software company that actually owns software. It’s not my proprietary product that runs my whole system.

That’s not something that, if it’s costing $100,000 or $100 million, I can just write off in the first year.

So, is the software renewable every year, or is it my product? Is it something I created as proprietary software? Those are all questions that you have to answer from that standpoint.

**Mark:** Right. And I think the other element that comes into play there is if I’m buying a company like a SaaS company, yeah, that’s software. But I’m not buying the software for aiding in the purpose of the business. I’m buying the software because it is the business.

That’s a good point.

Chris, we’ve got a couple of questions coming in.

**Christopher:** Yeah. And again, everyone, if you want to ask a question, go ahead and drop it into the Q&A panel. We’ll get to those as soon as we can.

Some good ones are coming in here, so we’ll keep those going and keep Mark from his rabbit holes. Help us all out here.

**Mark:** Please do.

**Christopher:** If you buy a business that’s 100% goodwill, how is that depreciated by the buyer?

**Mark:** Shannon, let me see if I can get that. That’s a 15-year depreciation schedule, right?

**Shannon:** It is.

Here’s the thing: I’ve never seen a deal be 100% goodwill.

There are caps that we utilize, usually when we’re doing tax planning. Usually, it’s 90% goodwill because we’re also looking at it from an audit-risk standpoint.

There’s no such thing as 100% goodwill. There just isn’t.

So, you’re going to have a combination. Ninety percent is usually the highest that we go with goodwill that we can substantiate.

**Mark:** Awesome. That’s actually good to know.

We often see 80% on our side allocated toward goodwill, and then the remaining 20% to things like inventory or domain names.

**Shannon:** Yeah. The 80/20 rule of most things in life is a pretty safe and solid rule to go with.

**Mark:** Awesome. Great.

**Christopher:** All right. What are some ideas for actions to take today for a future planned sale of a multimillion-dollar online agency?

A couple of points here. The corporate structure is currently an S corp. Is it important to change that? Second is that there are no hard assets at sale. Some asset allocation ideas?

So, there are multiple parts to that question.

**Shannon:** Yeah. Okay, I’m going to pull that question up so I can actually see it.

It’s from an anonymous attendee. That’s how it comes up.

Okay, anonymous. Is an S corp appropriate or not? Maybe, maybe not. I don’t mean to be vague from that standpoint, because I don’t know all your other moving parts in your personal life.

Sometimes the C corp strategy makes sense. Now, if you were starting an agency and you’re not going to sell for five years, I would say maybe a C corp strategy and using 1202 stock sale would be a really viable planning tool.

But if you’re already an S corp, from that strategy, it would probably behoove you, if you’re going to sell in the next few years, just to continue to be an S corp.

Make sure that you’re taking a reasonable salary and that everything is actually on your balance sheet properly.

And I think, Mark, you can talk about the fact that having clean books through due diligence is critical.

**Mark:** Yeah, we could talk all day about that, but I won’t. We’ll just say: Have clean books.

I do want to tack on this answer real quick here, and I want to get to the asset allocation ideas.

This process of planning the tax treatment of your sale isn’t something that’s done quickly. It takes some time.

I know, Shannon, you’re being put in a difficult spot of having to answer some of these questions with some definitive results. I remember running into this problem years ago when I asked another tax professional, for the purpose of an article, “What’s the tax treatment?”

He gave me what amounted to a written-out tree diagram of, “This is what it looks like.”

The action to take today—and this is going to be a pitch for you, Shannon, and to the attendees—is to hire a professional.

The action to take today is to find out what your current tax situation is. How are you currently set up?

As an S corp, that’s good to know. But as you said, are you being paid a reasonable salary, for one? What are the other elements? And what state are your books in as well? Are they clean, and does that need to happen?

The changes that you want to make should be planned.

Shannon, I’d love your input on this. I would say a minimum of 12 months in advance to have that idea. What would you say is a reasonable period?

**Shannon:** I was going to say 24 months, because from an audit-trail standpoint, I want to see that there’s meaningful change within the books and records and that we can actually track it.

When we’re looking at things from a due diligence standpoint, I don’t want something like, “Well, we got clean six months ago.” That doesn’t work for me.

So, I’m thinking 24 months from that standpoint.

There are a lot of ways, when we talk about how you should have a professional—if you’re running a multimillion-dollar business, you should have a bookkeeper who’s well-versed. You should have a tax professional that’s doing proactive tax planning for you.

Also, if you’re looking at selling within the next 24 months, I would think that you would actually probably bring on a due diligence team to see what’s clean or not.

A lot of entrepreneurs—and I’m sure you see this, Mark—I look at someone who’s getting ready to sell, and they’re paying for their car and their cell phone, and their books are pretty muddy. A lot of their personal expenses are running through their business.

Everything is commingled.

We really need to find a place where we’re not commingling personal expenses with business expenses.

Also, there are legal ways. We institute something called an accountable plan with all of our clients. So, there are legal things that you can actually write off through your business, but let’s do it the legal way and not just, “I use my Costco credit card for all my business and all my personal stuff.”

I think those are the things that, as we’re moving into a sales situation, we really need to pay attention to.

**Mark:** Yeah. And with that—I know we’re getting a few additional questions, which is awesome. Thanks, guys, for bringing those in.

Where was I going with this? I completely lost my train of thought.

A multimillion-dollar online agency—you mentioned having a good bookkeeper. Let me actually make another pitch: Hire a CFO, a fractional CFO, for your company.

If you’re a multimillion-dollar company, your company needs that level of financial analysis.

You mentioned at the beginning, Shannon, the idea that when you sell your company, if you’re depreciating assets in your company, you’re going to be recapturing that, or that accumulated depreciation is going to be recaptured as income.

Most of your accountants, if they’re halfway decent, are probably trying to mitigate your taxes. They’re probably trying to reduce that. So, they’re thinking, “I am doing you a favor by depreciating that computer that you bought, that desk that you bought,” whatever that might be that’s on the books.

They’re finding ways to depreciate some of the assets that your business owns without realizing or having an eye toward that exit.

You have this accumulated depreciation, which is now going to be recaptured, and that exit is not just a flat 20%, 23%, whatever the number might be, plus your state tax bill.

So, this is my pitch to say, if you’re a multimillion-dollar agency, level up. Get an outsourced CFO. Let them know that your plan is two to three years down the road to sell, so that the books can start having that in mind.

Then also look at having a tax professional look at the situation.

And I don’t want to bury the lead here as well. Chris, just for time management, I’ve done a podcast with you, Shannon, and I know that you’re sitting on a number of awesome tax-reduction strategies.

I would love, Chris, for the last 15 minutes of this AMA, if we don’t get to it before then, to really focus on some of the ideas she has for reducing the tax liability, if that’s cool.

**Christopher:** Yep, absolutely.

Anything else that you want to say on steps people can take today?

Okay. How is original content classified, say for an online training course?

**Shannon:** Basically, from that standpoint, in my mind—and Mark, I’m not sure how you would look at it—I would think it is going to be an asset that’s going to be depreciated.

**Mark:** Same here.

Content sites, we would typically, again, 80/20. But we would look at the content as being valuable in and of itself, right?

So, you’ve written something. You’ve created something. That content has value.

I might actually just value that content at 20% of the purchase price.

**Christopher:** Great. Nice and simple.

**Mark:** Super simple.

**Christopher:** And as always, guys, if you have questions, type them in. We’ve got a few more in line, but keep tapping them in. We’ll get to as many as we can.

The next one is a little bit longer, so bear with me as I read through it.

James writes: The question is around Qualified Small Business Stock and establishing a new business, or restructuring one that they plan on acquiring, as a C corp so it can be recognized as QSBS.

His understanding is that if they hold the C corp QSBS for five years or more, they can still sell that business and pay no capital gains on the gain. If they sell in less than five years, they can use the taxable amount to acquire a new business within 60 days, then retain that gain and eventually pull that amount out after holding the new business for five years.

Are you familiar with this strategy? Would you recommend it when rolling up a new entity?

**Shannon:** Okay. I love 1202. That’s Section 1202. I love it.

Here’s the thing, just to bring clarification.

First of all, the company has to have already been established as a corporation taxed as a C corp right out of the gate.

Basically, what that means is you can’t take that old LLC that you have lying underneath the couch, file a Form 8832, and then elect to be a C corp.

It has to be a C corp right out of the gate.

You had to have acquired that stock directly from the corporation itself in its original issue. So, it has to be original stock, not dirty stock, from that standpoint.

The company has to be under $50 million capitalized.

Now, there are companies that are excluded from this, so you’ve got to look and see if you might be excluded.

A service business in health, law, engineering, architecture, accounting, actuarial services, performing arts, consulting, athletics, financial services, banking, insurance—I mean, there’s a list of people who can’t utilize 1202.

So then, that’s my next question: Can you actually utilize 1202?

There are a lot of technical requirements to see if you qualify, because most businesses won’t, from that standpoint.

If your business is patents, copyrights, or trademarks, you could use a 1202 from that standpoint.

Let me see what the other components of this question are.

So, you can’t restructure. You’ve got to be a C corp right out of the gate from that standpoint. You’ve got to hold it for five years.

**Mark:** Shannon, what about in the case of an acquisition? Somebody buys an S corp, and they’re setting up a new C corp. Is that an asset sale?

**Shannon:** Yes. If it’s an asset sale, yes. If it’s a stock sale, no.

Remember, you’re acquiring the same footprint of that old company.

From the standpoint of, “If we sell in less than five years but use the taxable amount to acquire a new business in 60 days,” I’m going to have to look at that one.

You can reach out to me, and we can research that a little bit more.

I know that there are planning techniques that allow it. I’ve never seen it actually work.

There’s one thing to have it on paper, from the standpoint of it looks good on paper, but does it actually work?

I’ve not seen it work in 25 years.

**Mark:** Okay. Don’t you dare ask me to try and answer that question.

**Mark:** I’m not going to ask you that one. I do have one for you.

We’re talking a little bit about some unique deal structures and stuff like that in order to reduce your tax burden. Does that impact someone’s ability to sell their business? Does it reduce the number of buyers to try and get one of those creative deal structures?

**Shannon:** Yeah.

**Mark:** Anytime you try to force the tax structure—actually, let me back up there.

There’s kind of an understanding as to the tax structure that people are going to use for these transactions. We don’t often run into arguments over tax allocation. It happens.

I can think of one deal off the top of my head that fell apart because it wasn’t discussed early on, and the allocation made the deal not worthwhile for the parties. So, a lot of time was wasted.

If you’re coming to the table with a really specific deal structure that you need, it can cause some friction in a deal.

What comes to mind would be a UK transaction. The UK, in the past, has had what they call Entrepreneurs’ Relief for stock sales. In that situation, 10% was the effective tax rate if you were selling a UK company under a stock sale.

Conversely, if you’re selling that UK company as an asset sale, that person would be paying upwards of 50% in effective taxes.

Well, naturally, they want to pay 10%. But how many U.S. buyers are interested in acquiring the stock of a UK company and running a company in the UK?

It limits that buyer pool pretty quickly.

UK companies have historically been difficult to sell unless we have somebody willing to go through that. I went through that exercise last summer, in which we had a very complex structure to be able to get everything worked out. Honestly, it was beyond my expertise in this area.

Any of the other elements that we get into—and Shannon, again, I do want to make sure that we have time to talk about some of these things—they’re all fantastic when we start to get into it, as long as it doesn’t put an undue burden on the buyer.

If it puts an undue burden on the buyer, or more importantly, if the buyer is then in a less favorable tax treatment, obviously that’s going to cause problems.

But if there are other burdens or requirements on that buyer, that can have a negative impact on the sale and restrict your buyer pool, or just have somebody not willing to pay as much because it’s just not worth the hassle.

**Shannon:** No. Whenever we have helped facilitate the sale of a business, it’s all about making it fair and equitable on both sides of the ledger. It’s got to favor both people.

**Mark:** I have a question, Shannon, for you that deals with financing the purchase of a business.

When we talk about financing—seller financing specifically—it’s obviously a loaded question because we have lots of different types of financing.

There’s straight-up financing, saying, “I’m going to pay a million dollars. $200,000 is going to be paid over the course of two years in single $100,000 installments.”

We have stability payments, where the target is $100,000 after 12 months, every 12 months, but it can be escalated or de-escalated.

We have straight-up revenue shares. We have binary payments, which are, “If you hit this goal, you get the payment. If you don’t hit this goal, you don’t get that payment.”

So, they can be cut up in a lot of different ways.

Now I’m going to ask the overly simple question: When does that get recognized for tax purposes? When you receive the money?

**Shannon:** When you receive the money.

**Mark:** In all cases?

**Shannon:** Not in all cases. Again, we’re dealing with the tax code, so yes, no, maybe so.

When you’re talking about receiving installment payments, an installment sale is something where you’re basically receiving payments in equal installments.

It gives you the ability to usually defer the capital gains until the very end, in some cases.

With depreciation, if you’re recapturing depreciation as part of that installment sale, you’re going to pay the taxes then on the recaptured portion of the installment piece that you’re receiving.

That’s why I said you might not have taxation until the end, but you might have some now. It’s never just cut and dry from that standpoint.

Having said that, when we’re doing planning, one of the things I usually find is that my buyer wants this money up front. Now, there might be earnouts that we see.

When we have a buyer that wants substantially all of their money up front, an installment sale might work for a portion of it, or even a structured sale.

Just like what you’re talking about, where you negotiate a traditional sale and then you’re getting so many payments or an earnout over time, kind of like an annuity from that standpoint.

It’s great because you’re getting a return of your original basis and you’re not paying taxes on that. Then you have the capital gains portion of it or any interest.

So, there can actually be layered types of taxation on the sale of a business as well.

**Mark:** I think that might be a good segue into talking about some of the tax mitigation strategies.

I would like to bias somewhat toward the sell side. Obviously, I agree with you 100%. It’s got to be equitable, because if it’s not, your buyer is not going to do the deal.

You can’t ask them to pay twice as much in taxes just because you want to get a better deal.

But I’d love to get into some of your common strategies, thinking again in terms of the internet business owner—very asset-poor in terms of hard assets, usually just inventory if it’s an e-commerce business, maybe light equipment.

What are some ideas or ways that you know of to reduce that tax burden on their side?

**Shannon:** On the buyer side?

**Mark:** On the seller side.

**Shannon:** On the seller side, yes.

**Shannon:** It all boils down to planning.

One of the things that we try to do is either defer the tax or eliminate the tax. And when I say “eliminate,” people are like, “Is this legal? Can we do this?”

There are ways to legally eliminate taxation.

One of the most sought-after planning techniques that we use is actually coupling an installment sale with a monetized loan.

In an installment sale, you’re basically going to receive equal payments of the purchase price of your business over an equal period of time. Sometimes that can be two years, five years, even as many as 30 years.

You’re basically kicking the tax man down the road with that. But the problem is, you don’t have all your money up front.

If you don’t need all your money up front, an installment sale works just perfectly. But oftentimes, my entrepreneurs want their money up front so they can invest in a new business or go off and retire.

So, we’ve got to get the money into their hands.

The way that we do that is we actually structure what we call an installment sale coupled with a monetized loan, where they actually get a monetized loan up to 93.5% of the purchase price up front, and we defer the taxation for 30 years.

At the end of the 30-year period, the sale is actually recorded as an installment sale for 30 years on a tax return. In the final, 30th year, it’s recorded as a sale, and that’s when the taxation is actually calculated.

We’re using the time value of money in this kind of strategy so that you’re having all of your money up front to utilize and to invest.

We actually go forth and show them how much they need to invest to pay the taxes in 30 years, so they can segment that in their portfolio or what have you.

It’s just a clever strategy that individuals use to leverage their company for 30 years without paying Uncle Sam.

**Mark:** Let me just get this straight.

In that scenario, again using the nice round number of a million dollars, I get all that million dollars, but I don’t owe the taxes on that until year 30?

**Shannon:** Yes.

**Mark:** Because what I’ve done is I’ve taken a loan for 93%?

**Shannon:** 93.5%.

**Mark:** Thank you, 93.5%.

And then the installment payments are going against that loan. Is that correct?

**Shannon:** No.

What happens with this is a situation where your buyer has come to you, and let’s say it’s a million-dollar sale. They have a million dollars.

Your buyer gives a million dollars, and you’re going to actually get 93.5% up front because we have a third-party intermediary in there.

The way that this really works—and I’m trying to be aware of the time—is we have a situation where we’ve negotiated the sale of a business.

When it comes to close, we bring in an unrelated third party. Your buyer grants the lump-sum sales payment to the third-party dealer. That dealer then gives you a monetized loan for 30 years.

The loan is non-recourse, meaning they can never come back and get it from you. It doesn’t go on your credit report. It’s all a private transaction from that standpoint.

At the end of the 30 years—and there’s interest being paid and so forth, so it’s all legitimate under IRS guidelines—you simultaneously pay back the loan from the dealer. Then the loan is paid in full, and the transaction kind of unwinds from that standpoint.

But here’s the caveat to this. I think this is what’s important to understand.

The pushback I get from this strategy is, “Well, I don’t know what capital gains are going to be in 30 years.”

**Mark:** That was going to be my next question.

**Shannon:** Yeah. It always is.

But here, in my mind, is the real magic. It isn’t so much about the tax deferral. It’s about the time value of money, and it’s about inflation.

You’ve got to understand both of those key points.

Basically, I don’t know what capital gains are going to be in 30 years. What I do know is what your tax bill would be today, and I know what inflation has averaged.

Let me give you an example.

If inflation continues, let’s say, at 2.5% over the next 30 years, and the long-term capital gains rate stays at 20%, the tax bill on a $1 million transaction today—the tax bill in 2050, again, that’s 2050, 30 years from now—it’ll be about $94,000.

So, about 10% of the million dollars.

That’s less than half of the bill that it would be today.

Now, even if inflation were to spike like it did in the 1970s, you still have been able to use those funds for 30 years.

So, it’s not just about, “How much am I saving in taxes?”

It’s about the time value of money. It’s about the eighth wonder of the world, compound interest. And it’s about inflation and how that erodes away our purchasing power.

So, it’s going to erode away that tax bill 30 years from now as well.

**Mark:** Right.

Somebody asked what the interest is on a loan like that.

**Shannon:** It’s going to depend on several factors because of lending and things of that nature.

Here’s the way you look at it: You don’t actually pay the interest. You do pay it from an escrow account that’s already been set aside by that 6.5% that you’re giving up on the front end.

**Mark:** Okay.

**Shannon:** I know another question came in: What if someone passes away before the 30th year?

Here’s what we usually do in our planning.

The loan does not monetize for 30 years, so your estate holds that loan for the rest of the 30-year period.

Now, I have some people who are like, “Oh, I don’t want my wife or my husband or my kids to have to worry about it.”

What we do then is actually purchase life insurance. Usually, it’s a cash-value policy, so it’s building cash value.

If you never use it, great. If you do need to use it at your death, you can go ahead and pay those taxes at that period of time as well.

We try to build in, “What’s Plan A? Plan B? Plan C?”

I don’t like when a plan doesn’t come together, so we try to make sure that we always have a backup plan from that standpoint.

**Mark:** Gosh, one thing I love about working with financial planners is just the levels of planning that go into it, right?

It’s always mind-blowing when you see the different tools being used in concert with each other.

I want to go from what I consider to be complex—I consider that to be complex because it’s a different structure than we typically see—to something simpler.

Joe Valley sent this to me directly through the chat, and it’s a question we actually run into all the time.

**Mark:** It’s November 12th today. We have deals that are going to go under LOI today that are going to close right around the end of the year.

For tax-planning purposes, what does receiving the money mean?

So, I close. I sign my purchase agreement. I’m the seller. I’ve sold my business for a million dollars. I signed the paperwork on December 27th. The money is in escrow, but I don’t want to receive the money until January 1st.

Does it make a difference when I receive the money, or in what year am I going to have to pay that money?

Since we’re talking about the time value of money, we’ll get one year.

**Shannon:** Here’s the thing. It’s called constructive receipt.

Constructive receipt refers to the situation where income can be used despite the fact that the money is not physically received.

From an accounting situation, it does not usually apply in accrual accounting. But on a cash basis, an individual is considered to be in constructive receipt of income when they have the ability to control or utilize funds, even if they don’t have direct possession of it.

It’s kind of the same way when my business owners say to me, “Oh, I’ve got a $100,000 check that I received in December, but I’m not going to deposit it into my bank until January 1st because I really don’t have it.”

Well, constructive receipt would say you had control of that money.

So, do you have control of the business on December 27th? Do you have control of the funds?

If the funds are being held by the buyer or by the escrow agent, who has that constructive control?

From that standpoint, you can’t pay taxes on anything that you don’t have control of.

So, again, it’s a legal standpoint of who has control. The escrow agent? An extra agent?

From that standpoint, constructive receipt may not have actually transferred. But a revenue agent is going to make the argument: Did you have control over the business?

You’ve got to be able to back that up. It’s in how your agreement is written.

Again, if you’re accrual, it doesn’t matter. If you’re cash basis, the doctrine of constructive receipt stipulates that the receipt of funds by an agent is considered to be received by the principal at that time as well.

It’s sticky.

**Mark:** One more argument going right up for accrual-basis accounting, huh?

**Shannon:** Because you could always elect to be cash after you get through the sale of the business.

**Mark:** Right.

**Shannon:** Always do a change of accounting method.

Now, let me say this: If the money is in escrow and your agent does not have full control—and I think that’s something that Joe is pointing out—if you don’t have full control, then there’s not constructive receipt.

Again, it’s about what control your agent has at the time.

I think that’s being clearly defined. As long as you can clearly define that, then you can say, “Okay, you’re not receiving the monies until the 2021 tax year.”

Again, it goes back to the definition of all of those acting roles.

**Mark:** It’s amazing. They have 80,000 pages or something like that of tax code, and there are still murky areas.

I think we need to add, like, five more pages to clarify that.

We have about six minutes, and I was hoping we could get to one more tax-mitigation strategy, if you have time for it.

I’m going to say maybe dealer’s choice. Or, if I’m putting you on the spot, what about a charitable trust?

**Shannon:** Yeah. Here’s the great thing about any type of charitable strategy.

First of all, that’s where we need the most lead time to plan for a charitable strategy. If you have a letter of intent, then we can’t do a charitable strategy, period.

State law is very specific about that. So, you can’t have an LOI in place if you want to use a charitable strategy.

A charitable strategy is an elimination method. We can actually eliminate income taxes utilizing a charitable strategy.

A couple of things to keep in mind: We can’t have debt on the business. There can be no debt in a charitable strategy.

And you have to be willing to take your payments over a period of years.

One of the things I see a lot out there is that there are a lot of financial advisors who offer this kind of exit planning, and their fees are really high.

So, you’ve got to look at the ongoing fees of actually utilizing the charitable strategy over the course of the five, seven, or 10 years that you’re utilizing the strategy.

Basically, what you’re doing is giving your business to a charity, usually a charitable trust. Then that charity is selling the business.

Charities that are 501(c)(3)s do not pay taxes from the sale of appreciated assets. That’s where that whole tax code comes in from that standpoint.

Then, once all those assets are inside the trust, they give you an income. Sometimes it’s a lifetime income. Sometimes it’s a 10-year income.

But the income starts to be derived from that charity, with the proceeds being left to the charity and at least 10% of the sales price going to the charity as well.

So, it’s a great method if you’re charitably inclined. A lot of people are, and a lot of people don’t need all of the funds up front, because you can’t get all the funds up front.

It’s a really great way to eliminate taxes and fulfill your legacy as far as a charitable donation as well.

**Mark:** That’s awesome.

Chris, we’re up against the clock here, aren’t we?

**Christopher:** Yep, we sure are.

If you have any final thoughts, I’d like to hear those. But I’d also like to give people an opportunity to know how to reach out to you, Shannon, and how to reach out to you, Mark, if they need more thoughts on exit planning specifically or, Shannon, more thoughts about tax planning specifically.

So, Shannon, how can people reach out to you if they’re interested in more information?

**Shannon:** Right on AdvancedAccounting.com, there’s actually an icon where you can schedule a free consultation.

I’ll spend a half hour, and I’ll actually look at all of your financials and your tax returns and let you know my thoughts on how to mitigate taxes legally.

**Christopher:** Terrific. Mark?

**Mark:** Well, you guys hopefully know where to reach me: Quiet Light Brokerage, [email protected].

I love working with people like Shannon when we have that lead time for an exit, because when it comes to the sale of your business, it’s not just the money that you’re getting at close. It’s the money that you have to pay out as well, and Uncle Sam likes his share.

So, whatever we can do to reduce that through proper planning is something that I love to do. Hopefully, people like Shannon add a lot of value to the transaction.

Thank you, by the way, for coming on. I think you’ve shown your black belt in tax planning on this call pretty impressively.

**Shannon:** Thank you.

**Christopher:** All right. Well, thank you, everyone, for joining us. Thank you for your great questions.

We’ll be doing more of these AMAs and webinars in the future. You’ve got information on how you can reach out to both Mark and Shannon.

We’ve got a lot of great content on our website and on our YouTube page, so check those out.

And if you ever have questions about planning your exit—which you should be starting at least a year in advance—please feel free to reach out to any of our advisors through the website, and we’ll be happy to help you out.

Thanks, everyone, for joining us, and we will see you next month for another AMA.

Say bye, everyone.