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Considerations in Selling Your Business - Part 13: Tax Issues Part 3

by Patrick B. Mathis, Shareholder at Mathis, Marifian and Richter, Ltd.

Tax Issues - Part 3

The sale of businesses operated as S corporations, limited liability companies, partnerships, or sole proprietorships will have potentially different tax treatments than those affecting the sale of C corporations.

LLC agreementWhile the sale of stock in an S corporation, the member interests in an LLC or partnership interest, may generate capital gain much like the sale of stock in a C corporation, the sale of assets by these entities will generally avoid the double taxation affecting the sale of assets by a C corporation (although there are exceptions to this rule for “built-in gains” in S corporations). This is because these entities are treated as “flow through entities” for tax purposes whereby the income or losses of these businesses flow through and are reported on the owners’ personal income tax returns.

For instance, if the assets of an S corporation consist of inventory and equipment with a value and basis of $300,000, and goodwill with a value of $700,000, the tax treatment of the sale of those assets will flow through to the shareholders of the corporation. Consequently the sellers will offset gain on their portion of the sale price allocated to inventory and equipment against the basis in those assets (with potential depreciation recapture at ordinary income tax rates from the sale of the equipment). The sale of the goodwill will in turn flow through to the seller shareholders and be treated and taxed as a capital gain asset.

As a result of this flow through treatment, in many cases the total tax costs resulting from the sale of an S corporation’s assets will be substantially less because of the avoidance of the corporate level tax related to a C corporation.

Similarly, because limited liability companies are generally taxed as partnerships, the tax aspects of the sale of these businesses generally flow through to the owners and such a sale also avoids the C corporation's double taxation issue.

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