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When selling a corporate business, there are several ways to minimize the resulting tax bill. This article summarizes some of the more important tax and business considerations.
Existing corporate businesses can basically be sold in two ways: by selling either the business assets or the corporate stock. Buyers often prefer to purchase the assets of an existing business to have some protection from acquiring unknown or contingent liabilities, while sellers normally prefer to sell the stock of the corporation that conducts the business. A sale of stock by noncorporate shareholders (e.g., individuals) generally results in long-term capital gain that is taxed at a current maximum rate of 15%. (This long-term capital gain rate is currently scheduled to increase to 20% in 2013.) Because of the single level of taxation associated with a taxable stock sale, sellers usually prefer it to an asset sale followed by liquidation of the corporation, which may result in a greater tax liability.
The tax results of an asset sale are generally less favorable to the sellers since the corporation is generally liquidated to get the sales proceeds into the sellers’ hands. Thus, a C corporation is taxed on the gain from the asset sale. Then, the shareholders are taxed on the liquidation proceeds as if they had sold their stock for the cash and any property distributed in complete liquidation of their stock, resulting in double taxation.
While sellers generally favor stock transactions, they may prefer an asset sale in the following circumstances:
The selling corporation may have unused net operating loss or capital loss carryforwards that can offset any corporate-level gain on the sale of its assets.
If the assets to be sold have a high basis, there may be no corporate-level gain from the sale. If the shareholders’ stock basis exceeds the value of the liquidation proceeds, gain at their level could also be avoided.
An asset sale by a C corporation should be more acceptable to sellers who plan to use the proceeds to acquire a new business that will be operated in the same corporate shell as the old business (thus avoiding the second level of tax on the sale because the proceeds are not distributed to the shareholders).
As you can see from this discussion, a stock transaction often results in the best tax and business answer for the seller, so please contact us and we will be glad to work with you to structure any disposition transaction in the most favorable way, considering all tax and general business issues.
personally are generally treated as capital gains and losses. Although capital gains are potentially taxed at preferential rates, capital losses are usually unattractive because they can only offset capital gains plus $3,000 ($1,500 for married filing separate returns) of ordinary income (from wages, dividends, interest, etc.). Thus, if you realize large capital losses—but no capital gains, the tax benefit from the capital losses may have to be spread over many years in the future.
However, there is a tax provision that allows you to treat losses incurred from the sale of qualified corporate stock as an ordinary (rather than capital) loss. That’s beneficial because an ordinary loss offsets ordinary income. The deductible ordinary loss for this provision is, however, subject to an annual limitation of $50,000 ($100,000 if you file a joint return).
Of course, you don’t intend for your new business to generate a loss; however, this tax provision (known as Section 1244) is like insurance—you hope you will not need it, but it’s nice to have just in case. Any gain on the sale of Section 1244 stock is capital gain and qualifies for the favorable capital gains tax rates. Only losses are characterized as ordinary. Thus, there’s really no downside to qualifying for Section 1244 treatment if your initial capital structure can be set up to meet the requirements.
To qualify as Section 1244 stock, your new business must be a U.S. corporation (including an S corporation), and it must have no more than $1 million in capitalization at the time the stock is issued. The stock must be issued to an individual or partnership in exchange for money or qualified property. Stock issued in exchange for services will not qualify. In addition, the corporation must derive more than half of its gross receipts from noninvestment activities for a specified period (generally, five years) before the year the stock is disposed of at a loss.
Worker classification has generated controversy between taxpayers and the IRS for decades—with businesses pushing for independent contractor status and the IRS pushing for employee status. Businesses argue for independent contractor status to reduce or eliminate the cost of fringe benefits and payroll taxes. The IRS, on the other hand, wants workers classified as employees to facilitate the collection of payroll and income taxes and monitor taxpayer income levels.
Through the years, the courts have developed the concept of common-law employees and common-law independent contractors in precedent-setting case law. Under this concept, employees are workers over whom the business may legally control and direct both (a) what must be done, and (b) how it must be done. Independent contractors are workers over whom the business may legally control and direct only what must be done. The business may not control how, when, or where the work is performed. From this case law, the IRS has identified common-law factors that it believes most clearly show the degree of control between the worker and the business, and have grouped these factors into three general categories of evidence: behavioral control, financial control, and the type of relationship between the parties. The IRS has not, however, provided a clear line between independent contractor and employee status.
Now there is some relief for a business owner who previously classified workers as independent contractors and desires to classify those workers as employees and, in addition, limit the exposure to back taxes, penalties, and interest. The IRS recently launched a program that allows the voluntary reclassification of workers as employees outside of the examination context: the Voluntary Contractor Settlement Program, or VCSP. “This settlement program provides certainty and relief to employers in an important area,” said IRS Commissioner Doug Shulman. “This is part of a wider effort to help taxpayers and businesses and give them a fresh start with their tax obligations.”
To be eligible for the VCSP, a business must have consistently treated the workers in question as nonemployees and filed all required Form 1099 information returns for those workers for the previous three years. In addition, the business cannot currently be under an audit by the IRS or under an audit addressing the classification of the workers by the Department of Labor or a state government agency.
To participate in the VCSP, a business must agree to prospectively treat the class of workers as employees during future tax periods. The business must also pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates. In return for the 10% payment, the business will not be liable for any interest and penalties and will not be subject to an employment tax audit for those workers for prior years. However, a business participating in the VCSP must also agree to extend the period of limitations on assessment of employment taxes for three years for the first, second, and third calendar years beginning after the date on which the business has agreed to begin treating those workers as employees.
If the VCSP sounds a bit complicated, it is. But this may be a way to limit a business’s past and future liability for taxes, penalties, and interest.
Please contact us if you have questions concerning the VCSP or any other tax compliance or planning issues.