Tax considerations when selling family businesses

Why tax planning must begin years before the sale – and which structures can significantly increase net proceeds.

The sale as a major tax event

The sale of a family business is usually a once-in-a-lifetime event for the owner. Hidden reserves, often accumulated over many years or even generations, are realized in one fell swoop. This results in an extraordinary income tax burden, which – depending on the company's structure – can range from approximately 28% to as much as 47% of the capital gain.

German tax law is neither neutral with regard to legal form nor structure. Whether the family business is organized as a partnership or a corporation, whether a share deal or an asset deal is chosen, whether a holding company is involved or not – all of this has a significant impact on the tax burden.

The good news: Those who plan ahead can significantly increase their net revenue.

The sale of family businesses is an exceptional transaction, and tax optimization should ideally begin several years in advance. The available legal options can only be fully utilized if the appropriate structures are established in a timely manner.

No legal form or structural neutrality

Share deals in corporations: approximately 28% tax burden

If a natural person sells shares in a corporation (typically a GmbH) in which they hold at least a 1% stake or which they hold as business assets, the partial income inclusion method applies. Only 60% of the realized profit is taxable. The progressive income tax rate (including the solidarity surcharge) is applied to this portion, resulting in an effective total tax burden of approximately 28%.

For typical medium-sized transactions in the tens of millions, this order of magnitude represents the starting point for tax considerations.

Partnerships and asset deals: tax burden of up to 47.4%

The tax burden is significantly higher when a business or a share in a commercial partnership is sold. In these cases, the profit is generally subject to full income tax.

While a tax reduction may apply: If the seller is at least 55 years old, a reduced tax rate can be applied upon request. Nevertheless, the effective total tax burden, including the solidarity surcharge, can still amount to up to 47.4%.

The tax burden differential between corporations (approx. 28%) and partnerships (up to 47.4%) is therefore one of the central starting points for any tax structuring.

Previous change of legal form or contribution to a corporation

Against this background, the question regularly arises whether it makes sense to convert or contribute a sole proprietorship into a corporation before selling it.

In principle, this is possible – particularly via a tax-neutral contribution pursuant to Section 20 of the German Reorganization Tax Act (UmwStG). However, the shares received in return are subject to a seven-year holding period (entanglement).

If these shares are sold within this period, the hidden reserves will be taxed retroactively. However, the tax burden is reduced by one-seventh for each year that has passed.

In practice, this means that such a structure only unfolds its full effect with sufficient lead time. A planning horizon of at least seven years is regularly required.

Business tax: Often underestimated

Trade tax is generally not levied on sales by natural persons – at least not if it involves the sale of an entire business or a share in a co-entrepreneurship.

However, an important exception applies to the sale of partnership interests during the fiscal year. The profit accrued up to the date of sale is attributed to the seller. While trade tax can generally be credited, this credit is forfeited if the partner withdraws before the end of the fiscal year.

Herein lies a tax trap that is often overlooked.

Church tax: The often overlooked cost factor

Capital gains are also subject to church tax – provided church tax liability exists – as an ancillary tax to income tax. Due to the amount of the one-off income, this can lead to considerable additional burdens.

Besides leaving the church in a timely manner, it is possible to negotiate a partial waiver of church tax with the responsible church tax office on grounds of equity. However, experience shows that the handling of such cases varies among the authorities.

Pitfalls of business division and special business assets

In many family businesses, assets – such as real estate or intellectual property – are made available to the company by the shareholders for use. These situations often lead to supposedly "private" assets being classified as business assets for tax purposes.

In the case of partnerships, this is referred to as special business assets. In the case of corporations, a business division can exist if there are material and personnel interrelationships.

The practical implications are considerable: If the company is sold, the asset remains with the shareholder – however, for tax purposes, this results in a withdrawal or cessation of business operations. Consequently, hidden reserves are taxed without any corresponding inflow of liquidity.

Early restructuring is therefore essential.

Outsourcing of pension obligations

Pension obligations to managing shareholders regularly pose an obstacle in transactions. Buyers are often unwilling to assume such obligations.

The most common solution is the so-called "pensioner GmbH" (limited liability company). In this model, the liability is transferred to a separate company. It should be noted that this can lead to taxable effects, as the liability is valued lower on the balance sheet than it is economically.

Furthermore, careful attention must be paid to ensuring that no unintended income tax inflows are triggered.

The Cash Box: Tax optimization through holding structure

A key lever in tax planning is the so-called cash box, i.e., a holding company that is placed between the shareholder and the operating company.

The advantage: Capital gains at the holding company level are 95% tax-free for corporations. This reduces the effective tax burden to a minimum.

Even in companies originally structured as partnerships, significant tax advantages can be achieved through contributions – again, subject to the seven-year holding period.

With the planned reduction in corporate tax in the coming years, this advantage will increase even further in the future.

Tax optimization through relocation abroad?

The idea of saving taxes by moving abroad usually fails due to exit taxation. This tax fictitiously treats the relinquishment of unlimited tax liability as a sale at fair market value.

This largely neutralizes the tax advantage. Furthermore, it creates additional risks, for example regarding the company's tax residency.

The only advantage is the possibility of paying taxes in installments – however, this is rarely economically convincing.

Reinvestment and rollover

When financial investors are involved, it is common for the seller to partially reinvest and remain a minority shareholder.

A tax-neutral share exchange under Section 21 of the German Reorganization Tax Act (UmwStG) allows taxation to be deferred to a later exit. Precise structuring is crucial to avoid the unintended realization of hidden reserves.

Succession planning and timing: Transfer first, then sell.

An often underestimated aspect is the order of asset transfer and sale.

Business assets are eligible for preferential inheritance and gift tax treatment. If the business is sold first and only then transferred, this preferential treatment is no longer applicable.

Therefore, it is regularly advisable to bring forward the transfer of assets – taking into account the holding periods and payroll regulations.

Summary: Key recommendations for action

1. Plan early – tax planning often requires several years' lead time

2. Check the legal form – differences of up to 20 percentage points are possible.

3. Review the holding structure – especially if reinvestment is planned.

4. Identify and remediate special assets

5. Structuring pension obligations early on

6. Coordinate succession planning with exit strategy

7. Don't overestimate the benefits of relocation – it's usually not an effective solution.

8. Structure rollovers in a tax-compliant manner

Conclusion

Tax structuring is not a secondary aspect of a transaction – it is a key value driver.

Those who plan ahead can significantly increase their net profit. Those who act too late often lose several million euros – not due to the market, but due to avoidable tax consequences.

A good transaction therefore does not begin with the purchase agreement, but with the right structure – years beforehand.