Structuring a Business Sale to Minimize Income Taxes
Many of the considerations in structuring a business sale are dependent upon the type of entity that operates the business.
For the purposes of this post, we will limit our discussion to sales of businesses operating in the corporate form, either as S or C corporations.
In a business sale, the seller prefers to sell the stock representing the business ownership, but the buyer prefers to purchase the assets of the corporation. The seller wants a stock sale because it generates a capital gain, taxed at a 20% rate. The buyer prefers to purchase the assets because the full purchase price is allocated to the assets purchased, creating tax deductions for depreciation and amortization. In a stock purchase, the buyer steps into the seller’s shoes, receiving no tax benefit from the price paid until the business is sold. This issue is usually resolved by compromise, sometimes involving a price adjustment.
C corporation vs. S corporation asset sales
There is a significant difference between an asset sale by a C corporation and an asset sale by an S corporation. Sale by a C corporation results in double tax because the selling corporation is taxed on the gain on the asset sale, and the shareholders are taxed on the distribution to them by the corporation. Sale by an S corporation that has been an S corporation for at least five years preceding the sale is subject to only one level of tax. Because S corporations are pass-through entities that do not pay federal income tax, the entire gain is passed through to the shareholders for inclusion on their personal income tax returns.
If your business operates as a C corporation and you are contemplating sale, you should consider making an S corporation election. This will allow you to avoid a double tax, but only if the corporation has been an S corporation for at least five years prior to the sale. If the five-year requirement is not met, the S election will be disregarded for purpose of the sale and the sale will generally be treated as having been made by a C corporation.
In certain circumstances, a sale transaction can be structured in which the seller is taxed at favorable capital gains rates and the buyer receives ordinary deductions for a large part of the purchase price. This would occur if seller had personal goodwill, such as customer or supplier relationships not owned by the corporation. In this structure, the seller would recognize capital gain and the purchaser would deduct the price paid for the goodwill over fifteen years.
Learn more about selling a business
For more information on this, see my article which may be accessed using the following link: /wp-content/uploads/2016/02/Business-Sales-and-Personal-Goodwill-G-Shanker.pdf
This article is intended to present general concepts in structuring the sale of a business. If you are considering the sale of a business, you should contact a qualified CPA for specific advice.