Sooner or later—as the years spin by, the message becomes crystal clear—you must transfer your business. And if you're typical, the transfer will be made to one or more of your children. What's the most common form of transfer? Hands down, it's a sale of the business.
Let's follow the triple hit to your family when you as a business owner (say Joe) sell to your child (say Sam). Suppose Sam will pay Joe an amount equal to the fair market value of the business over a period of years plus interest.
The tax tragedy starts with Sam. Since he can't deduct the cost of the stock from his current income, he is forced to first earn the money, pay the tax and has only the balance to pay Joe. That's TAX NUMBER ONE. By the way, a smart tax move is to elect S Corporation status. This move accomplishes two purposes: (1) the interest paid to Joe becomes deductible by Sam, and (2) corporate profits can be withdrawn by Sam, free of a dividend tax, to pay Joe for the stock.
What happens when Joe receives the payments? The interest is fully taxable. The profit on the sale of the stock is taxable as a capital gain. That's TAX NUMBER TWO.
Let's review the stock purchase tax damage so far in round numbers. Sam must earn about $1,650 subject to a $650 income tax bite (including state tax) for every $1,000 paid to Joe. If Joe's tax basis for the stock is $100, he must pay capital gains tax of about $180 on the $900 profit. What's left?...$820, less than half the $1,650 Sam must earn. In addition, Sam must pay interest on the unpaid balance of the stock purchase price.
Finally, when Joe dies, the after-tax profit from the stock sale ($820) will be subject to the estate tax. Probably another 55 percent tax slice (taking $451) and leaving $369 for Joe's heirs. And that's TAX NUMBER THREE. To summarize: Only $369 is left out of $1,650.
Properly done, most business owners transfer their business to their kids without losing any dollars to the IRS.
Take Me Out To The Ballgame... And Win A Tax Deduction
It's business and fun all rolled into one...taking clients or customers to the ball game. Or giving these same or other strictly business contacts tickets to attend without you.
Is the cost of these tickets given to your business contacts deductible? As an entertainment expense?...NO!...unless you comply with some strict rules. As a gift? ...MAYBE! The rules to capture a deduction for tickets are simple, but very precise.
For example, if you and a potential customer go to a football game together, the tax rules for entertainment expenses come into play. At best you can deduct only 50 percent of the cost of both tickets, but only if the game precedes or follows a "substantial business discussion." To nail down the deduction, keep a record of the date, time and place where the discussion took place and, of course, the name of the person entertained and the nature for the business discussed.
Suppose you simply give a ticket to the opera to your customer. You have a tax choice: (1) you can deduct 50 percent of the customer's ticket as business entertainment if you meet the business-discussion rule, or (2) you can treat the ticket as a business gift. As a gift, there is no percentage limitation and no requirement for a business discussion. But your deduction cannot exceed $25 per person per year.
The sad truth is that many businesses get clobbered by the IRS for inadvertently deducting entertainment, travel and auto.