Tax Treatment of Selling a Sub Chapter S Corporation
Original post by Leslie McClintock of Demand Media
The sale of a subchapter S corporation is a taxable event. Generally, your profits from the sale of an S corporation are subject to capital gains tax rules. This means that the IRS will get a piece of any profits you make on the sale of an S-corporation.
The IRS calculates capital gains tax based on your basis in the company. The term basis refers to all the investments in the company you have made over the years. It includes the cost you paid for inventory, as well as money you paid to acquire the business. It also includes anything you have invested in capital improvements and machinery, minus deductions you made for depreciation. The IRS will assess capital gains tax on the difference between the proceeds from the sale of your company and your tax basis in the company. If you took a loss, you can use these losses to offset gains elsewhere in your portfolio, or up to $3,000 per year in ordinary income.
Stock Sales vs. Asset Sales
The way you structure the sale is important: If you sell the stock outright, the buyer picks up all your business liabilities, known or unknown, along with all your business assets. The buyer also inherits the basis of all the business assets. If you structure the sale as an asset sale, the buyer only buys the assets of the company, leaving you, the seller, with all the business liabilities. However, you will still be the owner of your company stock.
Treatment of Basis
If the buyer buys your business outright in a stock purchase, he inherits your tax basis in all your assets and inventory. If the buyer simply purchases the assets, his tax basis is whatever he paid for the assets, not whatever you paid for them. This is advantageous for the buyer -- especially if assets have appreciated in value since you bought them. Buyers may be willing to pay a premium price to conduct an asset purchase, rather than a stock purchase, because this may help provide them with higher depreciation deductions than they would under a stock sale -- resulting in greater after-tax profits. This is a frequent negotiation point in business sales.
Pass Through Treatment
There is no tax consequence to the S-corporation itself for being acquired in a stock sale. Instead, each of the selling shareholders handle the capital gains separately on their own individual tax returns. Generally, you must file a Schedule D with your individual income tax return to declare capital gains or losses. There is generally no taxable income from final distributions associated with the sale of an S-corporation, as the IRS considers this to be a tax free return of shareholder basis.
- Connelly Roberts & McGivney LLC; Stock vs. Asset Sale - Structuring the Deal; Michael S. Roberts
- NOLO: S Corporation Facts
About the Author
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.