Taxes: The Tale of Two Corps

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I work with a lot of people who are looking to sell their business. And one thing I’ve noticed is that many of the owners I’m talking with aren’t aware of how the tax code has changed since they founded their company.

Before 1958, the United States only knew two kinds of businesses: C-Corp and sole proprietor/partnership. The latter meant total liability so many business owners filed as a corporation. Few of these owners realized they could change their designation when the S-Corp was born.

The Other Corporation

The S-Corp recognized private, domestically held business with fewer shareholders. It allowed business owners to retain some protection in terms of liability but eliminated the double taxation upon the sale of their business. From what I’ve seen, countless business owners went on unaware of the change until the time came to sell. Then they faced double taxes that they could have avoided had they only known their options.

The difference between the burden you will bear as a C-Corp vs. an S-Corp is significant. Consider a C-Corp sold for $2.5 million. The owner pays his 35 percent in corporate taxes and makes $1.6 million from the sale. This puts the owner into a new personal income tax bracket, one that pays, on average, 24.3 percent. In the end, this owner will have paid more than $1.2 million in taxes.

This same business designated as an S-Corp would avoid the double taxation because S-Corps are recognized as a source of income for their owner and that income is directly tied to the performance of the business.

There are limitations for S-Corps and not every business is eligible. If you’re thinking of selling, talk with your tax advisor as soon as possible to determine if changing designations is a viable option. If you determine it is, the transition will take time and you’ll want it well underway as you begin preparing to transition your business.


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Published: 04/25/2016

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