Capital Gains Tax for Business Owners: Rates, Strategies, and Filing

For business owners, understanding capital gains tax is essential when selling assets like company shares, real estate, or other business-related investments. Properly navigating capital gains tax can significantly affect the net proceeds from a sale and influence decisions on when and how to sell.

This article covers the basics of capital gains tax for business owners, strategies to reduce tax liabilities, recent legislative updates, filing requirements, and how professionals can assist in managing these obligations effectively.

What Is Capital Gains Tax?

Capital gains tax is a tax on the profit made when selling an asset such as stocks, real estate, or business shares. For business owners, it determines how much of the sale proceeds you actually keep after taxes.

It’s the difference between the purchase price (or basis) and the selling price of an asset. If the asset is sold for more than its original purchase price, the profit is subject to capital gains tax.

This tax applies to various types of assets, including stocks, bonds, real estate, and business interests. For business owners, capital gains tax often comes into play when selling parts or all of a business, or other business-related investments. Understanding the timing and nature of these gains is essential to managing tax liabilities efficiently.

Capital gains are divided into two types: short-term and long-term.

• Short-term capital gains: apply when assets are sold within one year. They are taxed at the individual’s ordinary income tax rate, which can be as high as 37%.

• Long-term capital gains: apply when assets are held for more than one year. These gains are taxed at reduced rates of 0%, 15%, or 20%, depending on income level.

This difference encourages investors and business owners to hold assets longer, taking advantage of lower tax rates and promoting market stability.

Capital gains tax implications vary by asset type and jurisdiction.

• Real estate may involve exemptions for primary residences or depreciation recapture.

• Investors can use strategies like tax-loss harvesting to offset gains with losses.

Because rules are complex and differ by market, staying informed and consulting tax professionals is essential to minimize liabilities and optimize outcomes.

Short-Term vs. Long-Term Capital Gains

Short-term gains apply to assets held less than one year and are taxed at ordinary income rates (10%–37%). Long-term gains apply to assets held over a year and benefit from lower tax rates (0%, 15%, or 20%).

Capital gains are classified into two categories based on how long the asset was held before being sold: short-term and long-term. The distinction between these two is important because they are taxed at different rates.

Short-term gains: Held less than 1 year, taxed at ordinary income rates (10%–37%).

Short-term capital gains are profits from assets sold within one year and are taxed at ordinary income rates, which can be as high as 37% for top earners.Short-term capital gains

• Assets held less than 1 year.

• Taxed as ordinary income (10%–37%), same as wages.

• For business owners, quick sales often mean higher tax bills.

For business owners, this means that quickly selling business assets or shares can result in a higher tax bill. It’s often advantageous to hold assets for longer than a year to benefit from lower tax rates.

Long-term gains: Held over 1 year, lower rates (0%, 15%, 20%).

Long-term capital gains are taxed at lower rates—0%, 15%, or 20%—making them more favorable for business owners who plan to hold assets before selling.

• Assets held over 1 year.

• Taxed at lower rates (0%, 15%, 20%), depending on income.

• Favorable for business owners planning exits, since holding assets longer can significantly reduce tax liabilities.

This tax advantage encourages long-term investment and can be particularly beneficial for business owners who plan their exit strategies carefully. Holding business assets for over a year before selling can significantly reduce the tax burden on the gains realized.

How Capital Gains Apply to Business Owners

When selling business assets or shares, owners may face different capital gains tax rules depending on business structure and asset type. Understanding this helps avoid unexpected tax burdens.

Business owners face unique capital gains tax considerations, especially when selling business interests such as stock, partnership shares, or the entire business. The tax implications vary depending on the structure of the business (e.g., sole proprietorship, partnership, S corporation, C corporation) and the nature of the asset sold.

For example, selling shares of an S corporation or partnership interest may trigger capital gains tax on the appreciation of those shares. In contrast, selling assets owned by a C corporation might involve corporate-level taxes and potential double taxation when proceeds are distributed to shareholders.

Additionally, certain assets like goodwill, equipment, or real estate held by the business may have different tax treatments. Business owners must carefully evaluate the components of a sale to understand the full tax impact.

Strategies to Reduce Capital Gains Tax

Business owners can lower capital gains tax through long-term holding, installment sales, 1031 exchanges for real estate, or using Section 1202 small business stock exclusion. Proper planning saves significant tax.

Business owners can lower capital gains taxes with several methods:

• Hold assets >1 year to qualify for long-term rates.

• 1031 exchange (real estate): defer taxes by reinvesting in another property.

• Installment sales: spread income over years to stay in lower brackets.

• Charitable donations: donate appreciated assets for deductions.

• Section 1202 exclusion: reduce or eliminate taxes on qualified small business stock.

Finally, taking advantage of exemptions and exclusions, such as the Section 1202 exclusion for qualified small business stock, can significantly reduce or eliminate capital gains tax on certain business sales.

Capital Gains and The Tax Cuts and Jobs Act (TCJA)

The TCJA kept capital gains rates but changed income brackets, indirectly affecting how much tax business owners pay. Knowing these changes helps in planning asset sales effectively.

The Tax Cuts and Jobs Act (TCJA) of 2017 brought significant changes to the tax landscape, including provisions affecting capital gains tax. While the fundamental structure of capital gains rates remained intact, the TCJA adjusted income tax brackets, which indirectly influences the capital gains tax rates applicable to taxpayers.

For many business owners, the TCJA’s lowering of ordinary income tax rates can affect the tax bracket thresholds that determine whether capital gains are taxed at 0%, 15%, or 20%. Additionally, the act introduced limitations on certain deductions and increased the standard deduction, which can impact overall tax planning strategies.

It’s important for business owners to stay informed about how these legislative changes affect capital gains tax calculations and to adjust their financial planning accordingly.

Filing, Compliance, and IRS Requirements

Capital gains are reported on IRS Form 8949 and Schedule D of Form 1040. Accurate records of cost basis, sales price, and depreciation adjustments are essential to avoid penalties.

Proper filing and compliance with IRS requirements are critical to avoid penalties and ensure accurate reporting of capital gains. Business owners must be diligent in documenting transactions and understanding the forms required by the IRS.

IRS Forms used for reporting capital gains (e.g., Schedule D, Form 8949).

Capital gains and losses are typically reported on Schedule D of Form 1040. Form 8949 is used to provide detailed information about each capital asset transaction, including dates of acquisition and sale, cost basis, and proceeds.

Business owners selling assets related to their business must ensure that all transactions are accurately reported with supporting documentation. This includes records of purchase price, improvements, depreciation, and sale details.

Common mistakes business owners make when reporting.

Even experienced business owners can make errors when reporting capital gains. These mistakes often lead to higher tax bills, missed deductions, or IRS audits, making it crucial to understand and avoid them.

Common Mistakes

• Misreporting holding periods.

• Not adjusting cost basis for improvements or depreciation.

• Forgetting to report all transactions.

• Treating ordinary income as capital gains (or vice versa).

• Ignoring installment sale rules or exclusions.

Penalties for non-compliance.

Failure to comply with capital gains tax reporting requirements can lead to penalties, interest on unpaid taxes, and in severe cases, audits or legal action. The IRS can impose fines for underreporting income or filing inaccurate returns, which can be costly and damaging to a business’s reputation.

Timely and accurate filing, along with maintaining thorough records, is essential to avoid these penalties and ensure smooth tax compliance.

Read more: Understanding Federal vs. State Income Taxes for Business Owners

Read more: Top Tax Deductions Every Small Business Owner Should Know

How Pathfinding Consultants Can Help

Tax consultants guide business owners in structuring sales, claiming exclusions, and ensuring compliance. Their expertise can reduce liabilities and prevent costly mistakes.

Capital gains tax can be complex for business owners with multiple assets. Consultants provide tailored strategies to reduce liabilities, structure sales efficiently, and identify tax exclusions. They also ensure IRS compliance and proper documentation.

By working with experts, business owners can avoid costly mistakes, stay compliant, and maximize after-tax returns with confidence.

Conclusion

Capital gains tax is a significant consideration for business owners when selling assets or exiting a business. Understanding the difference between short-term and long-term gains, how the tax applies to various business structures, and the strategies available to reduce tax liabilities can greatly influence financial outcomes.

Effective capital gains tax management requires staying updated on law changes like the TCJA and meeting IRS filing requirements. With proper planning and expert guidance, business owners can reduce tax burdens, stay compliant, and maximize financial outcomes from asset sales.