C Corporation Status Impact on Business Exit Proceeds
If you are a C corporation and are about to exit your business, you may be in for an unpleasant surprise. Depending on factors like the structure of the sale, you could end up with a much higher tax burden than you expected.
A C corporation offers some important advantages for business owners.
But when it's time to sell, corporate tax advantages can quickly turn into a corporate tax nightmare. Instead of paying the amount of taxes you would expect to pay if you were selling a pass-through entity (e.g. a sole proprietorship, a partnership, or an S corp) the sale of a C corporation often incurs a higher tax rate and the possibility of double taxation.
What's the Problem?
In a C corporation sale scenario, buyers are hesitant to purchase corporate stock. Instead, they prefer to structure the sale as the purchase of corporate assets because it limits the amount of liability the purchaser assumes after the they own the company.
While this kind of a sale is advantageous for the buyer, it can be extremely costly for the shareholders. In a corporate sale, there is no such thing as a long-term capital gain for the corporation. If the transaction is structured as the sale of assets, the entire gain is treated as ordinary income and taxed at a corporate rate of about 30%. Once the distribution is made to shareholders, the gain is taxed again at the shareholders individual 15% long-term capital gain rate.
But if the transaction is structured as a stock sale, the gain is only taxed once. Rather than being taxed at the corporate level, it's only tax once, at the shareholders long-term capital gain rate of 15%-which is exactly how it would be taxed if the company had been structured as a pass-through entity.
Strategies & Remedies
If your corporation is faced with the double taxation of an asset-based sale, your best bet is to employ one of two strategies. The first strategy involves convincing the buyer to structure the transaction as the purchase of corporate stock rather than the purchase of corporate assets. If the corporation is a low-risk enterprise, you've got a decent shot at making a stock sale either a contingency or a concession.
The other possibility is to transition your company to a different business structure. With enough planning, it's possible to reorganize your business as a pass-through organization (most commonly an S corporation) to avoid paying the taxes associated with the sale of a C corporation.
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