When selling your business you can maximize after-tax proceeds by including the value of training and/or consulting in the value of your non-compete agreement.
In most instances upon the sale of your business the buyer will ask that you remain in some capacity with the business (for a specified period of time) to train him/her in certain facets of the business. The traditional method to account for this training/consulting is through the use of an employment agreement or a 1099 contract agreement. While both of these methods work, they ultimately result in less money hitting your pocket than if you were to utilize the non-compete agreement.
In order of greatest after-tax value to you, the options to structure future training/consulting are:
In a non-compete agreement, you will be taxed at ordinary income levels on the value of the non-compete but you will not be subject to self-employment tax. Your savings is the value of the self-employment tax or 15.3%.
When using a traditional employment agreement, your income is again taxed at ordinary income rates but you are subject to the employee portion of payroll taxes (FICA) or 7.15%.
As an independent 1099 contractor your income is taxed at ordinary income rates as was the case with a non-compete and a traditional employment agreement. However, now you will be subject to the full self-employment tax of 15.3% (12.4% for social security tax plus 2.9% for Medicare).
The cost/benefit to the buyer is completely different than your cost/benefit for each of these agreements so there will be a need to negotiate. It is important to have your accountant involved in these negotiations. We will consider these agreements from the buyer’s perspective in our next post.