When a business owner decides to sell the company, there are different scenarios to consider to ensure the sale benefits the seller as much as possible. When selling their business, owners should understand the tax implications related to the company’s corporate structure.
Owners who operate a proprietorship, partnership or limited liability company are only subjected to a single tax level. These entities must report taxes, but they do not pay them. Rather, the individual partners or members pay taxes on their portion of the profits. If an owner sells one of these types of businesses, the sale proceeds are taxed at the individual level.
If the owner operates a corporation, however, the tax issues become a bit more complicated. Unless the owner filed an S election, most corporations are C corporations by default. These companies are taxed on their own income at the current corporate tax rate, while individual shareholders are then taxed on any corporate distributions, such as dividends, BizFilings noted.
“Owners may find it more advantageous to sell stocks rather than assets.”
When it comes time to sell a C-Corp, owners can either sell the assets or the stock. For tax purposes, however, owners may find it more advantageous to sell stocks rather than assets. Selling the assets and then distributing the sales proceeds to shareholders can result in liabilities for both a corporate and shareholder tax rate that could exceed 50 percent. A shareholder’s sale of stock, on the other hand, would only incur a single tax, which could potentially be as low as 15 percent.
Buyers, on the other hand, may prefer to buy assets over stocks. True successor liability accompanies the purchase of stock, leaving the buyer open to lawsuits and potential backlash over previous corporate liability. In addition, stock sales do not depreciate and buyers could be left with a low asset basis locked inside the company.
According to the IRS, for federal tax purposes, owners form S corporations to pass on corporate income, losses, deductions and credits to their shareholders. By electing this status, shareholders will report the flow-through of income and losses on their individual tax returns, while the IRS assesses tax at individual income rates. This ensures that S corporations avoid double taxation. However, they must still pay certain taxes for things like built-in gains and passive income at the entity level.
If you are considering filing as an S corporation, your company must be a domestic corporation that only issues one class of stock and cannot have more than 100 shareholders. Of those 100, the company can only have allowable shareholders, such as individuals, certain trusts and estates. It should be noted that partnerships, corporations and non-resident aliens are not considered qualified shareholders for the purposes of an S-Corp. In addition, certain financial institutions, insurance companies and domestic international sales corporations do not qualify for S corporation status.
What are the differences between S corporations and C corporations? Flip through the SlideShare below:
Understanding the differences between selling a C-Corp and an S-Corp empowers owners to prepare their company for a sale that meets all of their objectives. An experienced corporate finance professional can structure the transaction to reduce the selling shareholder’s tax liability and ultimately provide more liquidity for the seller.