Do Not Overlook Tax Considerations When Selling Your Business

• Published date: 12 June 2021
• Subject Matter: Tax, Income Tax, Corporate Tax, Capital Gains Tax
• Law Firm: Ostrow Reisin Berk & Abrams
• Author: Mr Robert Swenson

When the COVID-19 pandemic first hit, economic uncertainty caused many business owners contemplating a sale ' as well as many prospective buyers ' to put their plans on hold. Now that there is some light at the end of the pandemic tunnel, interest in buying and selling businesses seems to be picking up.

If you are thinking about selling your business, be sure you understand the tax implications. The way that your business (as well as the transaction) is structured can impact your tax bill and, therefore, your net proceeds from the sale. Here are some issues to consider.

STOCK SALE VS. ASSET SALE

If your business is a corporation (either an S corporation or a C corporation), deciding whether to structure the transaction as a stock sale or an asset sale may have a significant impact on its tax treatment. Generally, a stock sale is preferable from the seller's perspective. That is because when shareholders sell their stock, the profits are generally taxed at favorable long-term capital gain rates ' currently a top rate of 20%, compared to a current top rate of 37% on ordinary income. In contrast, asset sales usually generate a combination of ordinary income and capital gains, depending on how the purchase price is allocated among the business's various assets.

From the buyer's perspective, on the other hand, an asset sale is usually the structure of choice. A buyer of stock generally inherits the corporation's basis in its assets. If the corporation has already taken significant depreciation deductions on those assets, there may be little or no basis for the buyer to write off. But a buyer of assets generally receives a basis equal to the portion of the purchase price allocated to each asset, generating valuable tax write-offs.

ENTITY TYPE

The seller's form of business is another important consideration. If the seller is a C corporation, for example, a potential drawback of an asset sale is double taxation.

First, the business pays corporate tax on any gains from the sale. Then the shareholders are subject to a second tax when the sale proceeds are distributed to them as dividends. (Note: It may be possible to defer the second tax by having the corporation hold and invest the sale proceeds.) Double taxation is not an issue for stock sales. The buyer acquires the stock directly from the shareholders, so there is no entity-level tax.

Double taxation usually is not a concern for S corporations. As pass-through entities, their income is taxed directly to...