Small Business Succession Planning: The Tax Implications You Need to Know
Transferring business ownership is never as simple as signing paperwork or receiving a check. There are serious tax implications that come with such a big transaction. It's critical that tax professionals share their expertise with those looking to transfer or sell their business, as well as with those looking to acquire it, to ensure they make the most tax efficient deal possible.
People work hard to build their businesses, so it's only natural that they want to leave them in the right hands when they're no longer running them. Their business transfer could happen voluntarily (retirement or opting to sell for a big profit) or, unfortunately, in some cases, sooner than expected (debilitating injury or sudden death). Regardless of the circumstances, it's important to make succession planning a priority.
Naming a successor or establishing a sale plan if the worst-case scenario happens is just one part of the transfer equation. Selling (or even transferring) a business comes with significant tax implications that many business owners, as well as interested buyers, are likely unfamiliar with. This lack of tax expertise could cost both buyer and seller alike lots of money in tax benefits simply because they didn't know what was available to them.
Thankfully, tax professionals like yourself are available to help all parties — small business owners looking to sell, family members who want to take over the company or eager buyers — understand the tax implications that come with passing on a business so the best deal possible can be made.
As a tax expert, it is your duty to educate your clients about the tax-related issues that could arise during the business succession planning process. Staying current with the most recent tax breaks and incentives, like the Inflation Reduction Act from 2022 or the proposed Tax Relief for American Families and Workers Act of 2024, will help you guide your clients to make the best possible decision for everyone involved.
Additionally, you will serve your clients well by presenting them with the negative impact that gift and estate tax can have on transferring wealth during business succession planning. Working alongside small business owners and educating them and the company's next leadership group can help ensure that the business will be transferred successfully from a tax perspective.
Keep reading to learn more about how you can help your clients craft a foolproof, tax-advantaged small business succession plan.
Structuring small businesses for tax benefits
How a business is set up can determine how much of a tax break it can enjoy. For example, here's a comparison of how a business with a partnership model and a C Corporation are taxed (1):
| Partnership | C Corp |
| Taxed a lower rate. | Profits are taxed twice (corporate level and any distributed after-tax profits are taxed at the individual level as dividend income) |
| Profits are only taxed once. | Combined individual and corporate tax rate create a higher effective tax rate. |
| With internal succession plans, profits are taxed so employees can share in profits and become a partner at a lower tax rate. |
Ideally, a succession plan will let employees have a stake in the company, but the purchase price could be too steep for some workers.
On the other hand, an outside buyer may look to structure the sale so their purchase is depreciated, which can be beneficial to the buyer and seller:
• Buyers could get their basis for depreciable assets, so they can regain their basis faster than they would in a standard stock or membership interest purchase.
• The seller benefits because they can keep most of their capital gain and can gain the upper hand on buyers who so desperately want those higher depreciation deductions.
The 2017 Tax Cuts and Jobs Act is Expiring — Now What?
In 2017, the U.S. corporate tax rate fell from a maximum of 35% to a universal 21%. The decrease was the result of the Tax Cuts and Jobs Act, which is scheduled to expire at the end of 2025. The flat tax provision is not due to end when the TCJA does, but another part of that act, a Qualified Business Income (QBI) Deduction of 20%, which could impact small business owners, is scheduled to go away.
QBI goes to businesses that owned passthrough entities like S Corporations or other partnerships. Before the TCJA was enacted, businesses could only deduct first-year depreciation on new property purchase. Afterwards, they were permitted to apply a 100% bonus depreciation on specific qualified property acquisitions after September 27, 2017, through 2022.
Losing this clause will be significant for small businesses — the amount they can deduct will continually decrease until it's gone in 2027 (2):
Year |
Bonus Depreciation Deduction Amount |
2017-2022 |
100% |
2023 |
80% |
2024 |
60% |
2025 |
40% |
2026 |
20% |
2027 |
0% |
Businesses were also allowed to use the bonus deprecation deduction on used acquisitions — as long as they didn't purchase it from a related entity. That valuable deduction is also set to vanish in 2025.
Tax professionals will be leaned on heavily to help small business owners figure out how to operate without these deductions as they look to transfer or sell their companies.
Are more tax incentives on the way?
The TCJA is expiring in 2025, but tax relief might be available to small businesses in other forms. For example, the House Ways and Means Committee passed HR 7024, also known as the Tax Relief for American Families and Workers Act of 2024 in January(3). The bill aims to restore pre-TCJA R&D-expensing provisions for qualifying costs through 2025. This would allow expensing for tax years starting on or after January 1, 2022, through and appropriate transition rule.
The proposed legislation includes a number of provisions for deducting specified research or experimental expenditures (SREs). A key provision allows taxpayers to deduct or capitalize and amortize domestic SREs, just like they did under the old rules. Small business owners will also have the chance to improve their cash flow and invest more in equipment and other work-related expenses. The act allows for immediate expensing, so businesses can lower their taxable income and, in turn, their tax obligation (4). Those savings can be put towards growing their business and future investments.
Develop a gift and estate tax strategy
Clients who opt to pass their business on to their family members could be subjected to an estate tax. You can help them minimize these taxes with a solid gifting strategy. Rather than hand the business over all at once, gradually transferring ownership would allow your client to leverage the annual gift tax exclusion and lifetime gift tax exemption. Both clauses can decrease their overall estate tax bill (5).
This strategy can be implemented by gifting pieces of the company — they just have to remain within the yearly exclusion amount. Valuation discounts can also be leveraged so a bigger piece of the company can be passed on without gift taxes kicking in.
Starting and maintaining a business is part of your legacy. Just having the opportunity to pass it along to loved ones or sell it for a significant profit would be impressive. However, this transition can be an even more successful one if the associated taxes can be minimized for all parties. A knowledgeable tax expert is the key to ensuring this happens.
Tax credit and incentive opportunities continue to evolve as new legislation is passed or as the IRS introduces new updates and/or guidance.
To gain a broader understanding of tax credits and incentives opportunities, as well as compliance considerations, visit the ADP SmartCompliance® tax credits resource page.
- https://www.smith-howard.com/common-tax-structures-for-succession-planning/
- https://allenbarron.com/how-does-the-tcja-sunset-affect-business-taxation-going-forward/
- https://www.adp.com/spark/articles/2024/02/what-to-know-about-the-tax-cuts-and-job-acts-tcja-amended-irc-section-174.aspx#:~:text=Known%20as%20the%20Tax%20Relief,through%20an%20appropriate%20transition%20rule.
- https://www.bench.co/blog/operations/american-families-and-workers-act-of-2024#:~:text=For%20small%20business%20owners%2C%20the,for%20further%20investment%20and%20growth.
- https://www.cbia.com/news/small-business/tax-savvy-succession-planning/
