Often times a business owner of a corporation considering a sale of the business will wonder how to structure the sale. Should the company sell its assets and then, after paying its liabilities and other expenses, liquidate and distribute the remaining sale proceeds to its owner, or instead should the owner sell the company stock to the buyer? The answer to this question could have significant tax consequences.
If the selling company is a regular “C” corporation (as distinguished from a so-called S corporation whose taxable income and/or gain, with some exceptions, is not subject to corporate level tax and usually only taxed once to its shareholders), generally it will have to pay federal and state income taxes on its gain from a sale of its assets, and then its stockholders will also be taxed on the net after-tax sale proceeds that are distributed to them on a liquidation of the company—resulting in a “double tax” on the sale proceeds..
So, for example, if a C corporation sells its assets in which it has a cost basis of $250 to Buyer X for $1,250, the corporation will be taxed for both federal and state purposes on a $1,000 gain ($1250-$250). Assuming a combined federal and state tax rate of 40%, the company would have net after-tax proceeds from the sale of $850 ($1250-$400 tax). And, if the corporation had no other liabilities or outstanding obligations, it could then liquidate and distribute that amount to its owner who would then be taxable on that distribution to him. If we assume that the owner had a $200 cost basis in his shares, was eligible for long term capital gains treatment and was taxable at a combined federal and state rate of 25%, he would be taxed on a $650 gain ($850 distribution-$200 cost basis), resulting in a tax of approximately $163. Thus, there would be $687 ($850-$163) of after tax proceeds available to the owner on the liquidation of his company. So what began as a sales price of $1250 when the company sold its assets would be reduced by the federal and state taxes payable both by the company and its owner to $687 by the time it reached the owner. This “double taxation” of the $1,000 gain on the asset sale would result in a combined tax rate of approximately 56% and a total tax of $563.
If, on the other hand, rather than an asset sale, the owner of the company sold the shares to Buyer X for the same purchase price of $1250, there would only be a single tax to the owner on a gain of $1050 ($1250 sale price-$200 cost basis in the stock). The company itself would not be taxable on that transaction. Assuming once again that the owner was eligible for long term capital gains treatment and was taxed at a combined federal and state tax rate of 25%, the tax to the owner would be $263. Thus, the owner would have after-tax proceeds of $987—nearly $300 (or 43%) more than he/she would have received if his company first sold its assets and then distributed the after- tax proceeds.
So why don’t owners of C corporations always choose to sell their stock rather than the assets of their company? Because buyers often balk and insist on an asset transaction since they can usually benefit more from an asset purchase. An asset sale often produces a greater after-tax return to buyers on their investment since they may be able to realize larger tax deductions in the future on the purchased assets than would be the case with a stock purchase. In addition, in an asset sale a buyer can specifically and knowingly select which of the assets it wishes to acquire and which of the selling company’s liabilities it wants to assume, as contrasted with a stock acquisition in which all assets and all liabilities are acquired regardless of the buyer’s intentions or wishes. Furthermore, in an asset sale a buyer is usually not liable for unknown liabilities of the selling company, unlike a stock deal where the buyer inherits all of the purchased company’s liabilities and obligations, whether they are known or unknown.
Given these competing interests of a buyer and seller in a corporate sale, a potential seller needs the advice of qualified professional advisors to guide him/her in selecting, negotiating and structuring the appropriate form of transaction.
The business and tax lawyers at General Counsel, P.C. are well versed and experienced in these matters and would be delighted to assist you with the sale of your company.
If you are thinking about selling your corporate business, or any other form of business, feel free to call or e-mail Norman L. Eule, Esq. at 703-556-0411 703-556-0411 or firstname.lastname@example.org.