Tax Implications of Selling Your Funeral Home

BY RAYMOND L. BALD, CPA, CFE & RONALD H. COOPER, CPA

So you’ve worked your tail off for 20, 30 or maybe even 40 years and it’s now time to pass on your funeral home. Back in the day, funeral homes were largely family-owned businesses with each successive generation assuming ownership from the previous one. However, that’s become less common. It’s more likely you’ll be selling your practice to an independent third party and the post-sale proceeds will represent a significant portion of your retirement nest egg. You’ll settle on a price and pay off the bank at the closing. But it doesn’t end there. You’ll eventually need to pay Uncle Sam his share and three factors will significantly affect how much that is.

The first important factor is your type of business as it will determine what you are selling and how you are selling it. Sole proprietorships and partnerships will sell the assets of the company (e.g. vehicles, equipment, real estate, goodwill, etc.) A corporation will either sell its assets or the owner(s) of the corporation will sell their stock (whoever owns the stock owns the company). However, stock sales are very rare due to the negative legal and tax ramifications for the buyer.

Corporations can either be taxed as C-corporations or S-corporations. S-corporations (and partnerships) pay no taxes. Rather, their income “flows through” to the personal returns of the owners and they pay the taxes on their share of the flow-through income. Unlike S-corporations, C-corporations pay their own taxes which may sound good. However, C-corporations are plagued with a “double taxation” issue which can be especially brutal when they are sold. Consequently, few small businesses operate this way today. It's not uncommon to find older funeral homes still operating as C-corporations since this was a common form of ownership many years ago. Although this poses some tax challenges, there are some strategies available to lessen the potential double tax burden. Likewise, planning is key in these situations.

The next important factor is the allocation of the purchase price to the various assets being sold. The tax code categorizes various types of income (e.g. ordinary income; short and long term capital gains, etc.) and the various assets being sold will generate these various categories of income. For example, the gain on equipment being sold will typically generate ordinary income while the gain on goodwill will generate a long-term capital gain.

Why is this important? Because the tax code applies different tax rates to these various categories of income. For example, a long-term capital gain is normally taxed at a lower rate than ordinary income. Therefore, allocating more of the purchase price to those assets which generate a long-term capital gain will result in a lower overall tax.

The allocation of the purchase price will also have tax consequences to the buyer which may compete with the seller’s preferred allocation. Furthermore, the tax returns of both the buyer and the seller will include a form reporting the allocation of the purchase price which should agree with each other. Therefore, it's very important for the parties to agree upon the allocation of the purchase price prior to the closing. The closing documents should include the allocation of the purchase price and the information each party will need to report purchase/sale in their respective tax returns.

The last important factor is the method of payment. Ultimately it is most often best for the seller to receive full payment at closing. This puts cold hard cash into the seller’s hands and eliminates any risk of non-payment. The reality, however, is some seller-financing may be necessary to make the deal work. The tax code treats this type of arrangement as an installment sale. Under this arrangement, the seller will normally recognize income only as payments are received on the note. This spreads out the recognition of the gain over time and could result in a lower effective tax rate on the gain since the entire gain is not recognized in a single year. The offset is the seller assumes the financing risk and will be in a second position to the bank if the buyer were to default.

There are a couple potential tax traps associated with installment sales. The first is connected to the purchase price allocation and income categories. Only the capital gain portion of a sale can be deferred and recognized as received through an installment sale. Any gain categorized as ordinary income will be taxable immediately even if it is paid through an installment sale. That means you would have to pay taxes on income you haven’t received yet (i.e. “phantom income”.) Therefore, when seller financing, it’s important to receive enough cash up front to cover the taxes that will be due immediately.

The second potential tax trap with installment sales is in connection with S-corporations. As mentioned earlier, buyers rarely purchase the stock of a corporation. Rather, the S-corporation will sell its assets in return for cash and a note, and these become the only remaining assets in the company. Now that the business is sold, the S-corporation is often then liquidated by distributing the cash and note to the owner. As long as the S-corporation holds the note, it will only recognize income as it receives payments on the note. Alternatively, if the note is distributed out to the owner, the full gain remaining on the note is recognized immediately resulting in phantom income. This can be a tax disaster depending on the size of the note, so never liquidate your S-corporation without consulting your CPA. The value of your funeral home may be the largest component of your retirement assets, so minimizing the tax liability on its sale is critical to preserve what you’ve worked so hard to accumulate. Each business is unique so be wise and partner with your tax advisor to plan a selling strategy that will work best for you. FBS

This article is meant to provide general information and should not be construed as legal or tax advice or opinion and is not a substitute advice of counsel, CPAs or other professionals.

Raymond L. Bald, CPA, CFE is a funeral home tax accountant and consultant with Cummings, Lamont & McNamee, PLLC. He can be reached by phone at 603772-3460, or you may email him at rbald@clmcpa.com

Ronald H. Cooper, CPA is a funeral home accountant and consultant with Ronald Cooper, CPA, PLLC. He can be reached by phone at 603-671-8007, or you may email him at ron@funeralhomeaccounting.com.