How Are Web Businesses Taxed When Sold – Cap Gains/Ordinary Income?
The fastest-growing businesses are now online as more consumers seek services on digital platforms. With half of the global population now online, billions of dollars in investment continue flowing into web-based startups. Advanced technologies such as artificial intelligence (AI) and the Internet of Things (IoT) continue shaping the digital landscape.
If you have built and stabilized eCommerce startup, it has taken a lot of time and energy to achieve this success. A high number of startups fail within the first year of launch, and those that succeed are in high demand.
A recent report shows that global e-Commerce retail sales achieved 209% year-over-year revenue growth. Such numbers have seen billions of dollars going into Mergers and acquisitions (M&A) transactions. Investors are on the lookout for viable web businesses they can grab for a good price.
Tax Considerations When Selling an Online Business
If your strategy was to exit your web business eventually, this is as good a time as any to make your move. There’s a lot of money flowing into web-based enterprises. By selling now, you can get good value for your investment.
If you have decided to put your established online business for sale, we help you create a well-structured exit plan. One of the most important considerations our team looks into is taxation. In their rush to sell, many entrepreneurs don’t take time to understand the tax implications. When you put up your profitable online business for sale, The Internal Revenue Service (IRS) will be closely watching.
Like with any other transaction that earns you money, selling your internet business affects your tax bill. If not careful, you might find yourself with less than half of the earnings after closing the deal. Many investors ignore the tax question until it’s too late. This risks diminishing the returns from their investment.
For this reason, working with a business transfer professional who will help find the best timing to minimize or defer these taxes. Taxation is not an exciting topic, more so when dealing with the unique web-based business model.
The main question that emerges is whether your earnings fall under ordinary income or capital gains. It is a crucial consideration that determines the amount of money you eventually get in the bank after the sale.
Ordinary Income Vs. Capital Gains
When planning your exit, your advisor not only focuses on the selling price but also on the taxes. The primary consideration is what tax class your web-based business earnings will fall. Here are the two taxation considerations:
Ordinary Income Tax
Income tax is paid on earnings from interest, dividends, royalties, employment, or self-employment. This income can be in the form of services, money, or property. This kind of tax is based on your specific tax bracket. Lower-income individuals pay lower taxes than higher-income taxpayers. This on the premise that if you have a higher income, you have a greater capacity to pay more.
If your web business is a proprietorship, partnership, or you are a shareholder, the taxation of the sale is according to your tax situation. The sale will have consequences on your overall personal tax returns.
On the sale of your business, you might find yourself moving into other income tax brackets. This means the tax impact becomes more than just the tax on the sale. It might even increase your tax on other incomes.
Capital Gains Tax
A capital gains tax is a tax on profits earned from the sale of a non-inventory asset. It is a common tax in stock investments or real estate property. This class continues growing with the emergence of new business models.
The capital gain, in this case, is the total sale price of your asset minus the original cost of the asset. A capital loss, on the other hand, occurs when you sell an asset for less than the original price.
Capital gains tax is only due on the sale of an asset. In this case, you don’t owe any tax until you sell your online business. The Capital gains tax rates depend on the duration an investor held an asset. For assets held for less than a year, ordinary income rates apply. For an asset you’ve held for more than a year, the long-term capital gains apply.
In the case of your web-based business, capital assets will range from properties or depreciable personal property used in eCommerce business and which you held for more than one year. Profit from the sale of intellectual property, copyright, or artistic composition or similar property will fall under ordinary income and not capital gain.
Other non-capital assets include Stock in trade, inventory, and other property for sale, accounts or notes receivable, depreciable property used in your trade or business, and copyright. Most of the property you own in your online business falls under capital assets. From business assets or investments, personal assets to assets for pleasure, the sale of these will result in capital gain tax.
To determine capital gain or loss, you get the difference between the amount you realize from a sale or exchange of property and original cost (plus certain additions). Remember that your individual’s income tax bracket determines the Long Term Capital Gains Tax Rates.
Non-Capital Assets and Other Taxes
After the sale of non-capital assets (personal property, inventory, and receivables), the profits are subject to ordinary income tax rates. Taxes on ordinary income can range from 10% to 39.6%. Other tax implications include state and local taxes, additional Medicare tax, alternative minimum tax, and the net investment income tax.
Handling the Tax Issues
There are so many variables that can affect your tax situation when selling an online business. Our exit planning team works closely with you from the initial consultations to work out all these factors. We have tax specialists who have worked with these unique business sales, and they understand the tax implications. With the right exit strategy, our advisors guarantee a smooth process and the best value from the sale.
Let’s hop on a quick call to discuss the timing and prospects of an exit based on your goals and the current state of your business. Schedule your free exit consultation today.
You're guaranteed to come away from the call with:
Clarity about your business
Knowledge of the landscape
A high-level exit plan
A rough valuation
Specific next steps
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