Before you make a move: Tax implications when selling your business
Even successful, long-established business owners are prone to missteps when making decisions about divesting from their company, especially when those actions accompany a move out of state. Assumptions about how relocating to another state will your lower tax liability when you sell could have you running afoul of tax laws if you’re not careful.
Without a full understanding of both the tax laws of the state where your business is located and the new state you have your sights on, you could be overlooking important considerations regarding the structure of the sale and the timing of that move — and what those may mean for tax purposes.
Here are areas where common misconceptions arise about tax liability when a business seller moves out of state:
1. Rules about installment sales
With plans to move from a high-tax to a low-tax state, people may think that setting up the sale of a business so that the seller receives payments over time, rather than in a single cash transaction completed while still in their former state of residency, will save them on income taxes under the tax laws of the new state. But states don’t automatically follow this installment tax treatment of deferring tax payments until you get the cash — even though that’s how the situation works for federal taxes.
When you move out of state and stop filing taxes there afterwards as a result, the old state will sometimes accelerate the recognition of that income, even if taxpayers haven’t received cash yet under the terms of the installment plan. These states, including Massachusetts (AP 201) and Minnesota (Schedule M1AR), would let you defer tax payment if you remained in the state, but not if you stop filing after you leave. Your best option is to file a form in your former state promising to continue to file tax returns in that state for as long as you are receiving payment under the installment note.
If you don’t continue filing there, even though you haven’t received the installment cash yet, you’d be obligated to pay tax in full in advance. The point is to be aware of whether the state where you are selling your business recognizes the deferral treatment when you move out of state. You don’t want to be in a situation where you decided to move to a particular state when you sold your business because you assumed you wouldn’t owe taxes to your old state under the terms of the deferred payment agreement. This understanding could affect your decision to move, the timing of your move or your use of the installment sale method.
2. Selling a partnership interest
If you moved from one state to another, say California to Florida, and then sold intangible property like corporate stock, the source of the gain for state individual income tax purposes is the state you reside in at the time of sale. (The opposite would be true for tangible property like buildings or land, the gains on the sale of which are sourced to the place the property is located at the time of sale.)
A potential trap is with sales of partnership interests. Some states consider these to be intangible sales, so that moving from California (with a high income-tax rate) to Florida (which has no income tax), and then selling the partnership interest, would result in no state personal income taxation of the resulting gain.
Other states take the opposite view towards sourcing with regard to partnership interest sales and take what is often called a “look-through” approach to sourcing the resulting gain. Idaho and Minnesota, for example, source the gain on the sale of a partnership interest by an individual based upon the percentage of the partnership’s operations — such as property or sales — conducted in the state. Therefore, states like Idaho and Minnesota would tax you on a portion of your gain from selling an interest in a partnership that operated there, even if you sold your interest after you moved away. The treatment of this issue is less clear in other states like California.
A consultation with a tax advisor familiar with the laws in the state where the partnership operated and where the seller lives can help you dealing with these kinds of complications.
3. Selling a business’s assets instead of selling an interest in a legal entity
Sometimes people selling a business believe that they can eliminate state income taxation on the gain from the sale simply by deferring the sale until after they move. However, because states can always tax nonresidents on income that is sourced there, individuals need to carefully consider how their decision on how to structure the sale may influence which state the gain is sourced to.
When business owners sell tangible assets — a sale structure often favored by buyers because it generally allows them to claim generous depreciation deductions — the sellers are on the hook for income taxes on income sourced to all the states where the assets are located, even if they don’t reside in those states at the time of the sale.
In addition, these sellers also may need to collect sales tax on those sales of business assets like trucks, computers and other business equipment. Even though states may have so-called “bulk sale” exemptions for sales of all or substantially all the property of a trade or business, these exemptions (such as in California) sometimes have “traps for the unwary” that, unless precisely followed, can add a significant sales tax cost to the sale of business assets.
It’s important to remember that moving to a state with no individual income tax doesn’t mean you don’t owe state income tax related to a post-move sale of business assets.
4. Timing of move date and business sale
If you intend to sell your business in close time proximity to when you move, that fact may work against your claim that you changed residences if you are audited.
For example, if you sell a business for millions of dollars the day before you claim to move to another state, especially a state like Florida that has no income tax, the state you are moving from is unlikely to accept your assertion that you stopped being domiciled there prior to the sale. Determining your domicile, meaning your true, primary residence, is a question informed by your intent, but auditors can always look at objective evidence — such as having a major income transaction soon after a claimed break in domicile — to determine what the seller’s intent actually was.
Remember that states have access to a variety of information about you — from your bank accounts to your car registration and license information to voting information — that can be used as evidence as to whether and when you actually intended to permanently move from one state to another.
If you have an enormous income transaction soon or immediately after you assert that you changed residency, the state is much more likely to trigger a residency audit of the tax years surrounding the transaction.
How Wipfli can help
Making decisions about your stake in a business as you prepare to move on from it, and potentially leave the state that’s been your historical domicile, carries significant financial and tax ramifications. Well before you begin packing your bags, it would be wise to talk to an experienced advisor to help you understand the SALT implications. Wipfli advisors can help you set up a plan that maximizes your financial benefits, protects you legally and still enables you to relocate to the place you’ve been dreaming of. We help you begin a new chapter with confidence and peace of mind.
Sign up to receive more valuable tax insights in your inbox and learn more in these related resources:
Living in a high-tax state? Here’s how to establish residency in another state
Structuring a Transaction: Ways to minimize income tax implications for sellers
Increasing saleable business value: Decreasing a buyer’s perceived risk
