Selling a business

Installment sales, and trading certainty for tax

The buyer wants to pay over time. Some down now, the rest across several years, with interest. Your first instinct is that this is worse than being paid in full, and your second, once somebody mentions the tax, is that it might be better. Both instincts are half right.

I had a seller who was offered two versions of the same deal. One paid everything at closing. The other paid a portion at closing and the balance over four years at a modest rate of interest, for a somewhat higher total. He wanted to know which was the better number.

It is not a question about numbers. It is a question about what you are willing to carry.

Spreading the payments is not simply good

The version people arrive with is that taking the money over time is the clever choice, because the gain gets spread and a spread gain is taxed more gently. The tax half of that is often true. The word simply is doing far too much work.

You are not just changing when the money is taxed. You are changing whether you get it.

What an installment sale actually does

In broad terms, instead of recognising the whole gain in the year of the sale, you recognise a proportion of it as each payment arrives. The gain follows the money rather than the contract. Interest on the deferred amount is treated separately, as interest.

The reason that can matter is that a large gain landing in one year can push income into higher bands and can interact with other thresholds, surcharges and phase-outs that sit at particular income levels. Splitting the same total across several years can keep more of it in lower territory. How much that is worth depends on your other income in each of those years, which is why it is modelled rather than assumed.

Not everything is eligible for that treatment. Certain categories, including some inventory and some depreciation recapture, are generally accelerated into the year of sale regardless of when the cash turns up. That is one of the sharper surprises in this area, a tax bill in year one that is larger than the cash received in year one.

Spreading the gain also spreads the risk. You have become a lender to the person who bought your business.

That is the whole trade. A buyer paying over four years is using the business you sold them to generate the money they owe you. If they run it badly, the payments are at risk. You no longer control the asset and you still depend on it.

What the difference can be worth

As a range, spreading a large gain across several years can reduce the overall burden by a meaningful amount compared with recognising all of it at once, and on some profiles it makes very little difference at all. The variables are the size of the gain relative to your ordinary income, how many years you spread across, your state, the mix of assets, and where the thresholds sit in each of those years.

There is a real case in the other direction too. If rates rise, or if your income in later years is higher than it is now, deferring can cost you rather than save you. Thresholds and rates change, so this has to be modelled against the years in question rather than against today.

What it requires

• Security. A personal guarantee, a lien on the assets, or both. An unsecured promise from a new owner is not a plan.
• A real agreement, with a payment schedule, a stated interest rate, remedies on default, and terms about what the buyer may and may not do with the business while they still owe you.
• A clear view on whether the business survives without you, because that is what the payments depend on.
• Modelling of the accelerated items, so the year one tax and the year one cash are compared before anybody signs.

I would add one more. Decide in advance what you will do if they stop paying, and be honest about whether you would want the business back. Taking it back is the usual remedy, and for many sellers it is the last thing they want.

Who this is not for

Sellers who need the cash now. If the proceeds are funding a retirement that starts immediately, a house, or the repayment of debt that is charging you more than the buyer is paying you, the tax argument is irrelevant. Certainty has a value and for some sellers it is the only value that matters. I have never regretted telling someone to take the cash.

And sellers who do not believe the business runs without them. This is the one people will not say out loud. If you suspect that the relationships are yours, that the key customers stay because of you, or that the new owner is buying something they cannot operate, then financing them is a bet on a proposition you have already privately doubted. Sellers talk themselves into it because the total is higher. The total is higher precisely because the risk moved to you.

It is also a poor fit where the buyer is thinly capitalised and offers no security, or where most of the value falls into categories that are accelerated anyway. In that second case you carry the risk without getting the deferral, which is the worst version of both.

When this gets decided

In the deal, not afterwards. The structure of the payments, the security and the interest rate are terms, and terms are negotiated before signing. There are elections and mechanics that sit with the return, and some can be handled later, but the commercial substance cannot be retrofitted.

So the modelling has to happen while the terms are still being discussed, which in practice means before the letter of intent is settled rather than after.

The point

This is a planning question, not a preparation question. By the time the return is prepared, the payment schedule is a fact and the risk is already yours. Charter works with sellers while the terms are still open.

This is general information, not advice on your own situation. Whether any of it applies to you depends on facts this article does not know.