Basis is a term that represents the financial investment you have in your business. This is important because, similar to other investments, you are taxed on the growth, not on what was invested. Your basis gets deducted from the sale price when you sell the business. For example if you sell the stock of your business for $1 million, but your basis is $200,000, you will only pay tax on the difference, the $800,000.
How is basis calculated?
• Take the original amount you invested in the business
• Add all amounts passed through to you (if S Corp or Partnership) as taxable income
• Subtract all deductions passed through to you (if S Corp or Partnership), even if they were not deductible
• Subtract all draws/distributions you have taken
• The result is your basis in the business.
Example: You start the business in 2010, by investing $50,000 into it. Let’s assume this is an S Corporation. Every year, the business has net income of $100,000, but you take $40,000 per year in draws (in addition to your salary). So, every year, your basis goes up another $60,000 because you add the $100K net income but subtract the $40K you took out. Let’s say you do this for 10 years. Your basis is $50,000 original investment, plus $60,000 times 10 years or $600,000. At this point, you find a buyer for your business for $2 million. Subtract your basis of $650,000 and when you sell the business for $2,000,000, you will only pay tax on the difference or $1.35 Million. How much tax can vary greatly as we will see later in this book. In general, you can expect your tax bill to be at least 15% of the sale above your basis, – unless you use one of the tax-minimizing ways in my book, 50 Ways To Leave Your Business, coming soon to Amazon in print and e-book form.