The way to start off the question really should be…do you know what type of entity your company is and do you know why?  Most business owners decided to incorporate because “everyone” told them they should.  So they called their local attorney, referred by a friend , and asked them to incorporate the company before moving back into their daily grind.  The problem is that there are consequences to this decision that can cost you thousands of dollars every year and maybe 10’s of thousands at the sale of your business.

I am no attorney or CPA, so this is not legal or tax advice, but it is real life advice.  Every business owner should know what type of corporate entity… they are along with the positive and negative consequences of each.  In a quick overview, the most used corporate entity types are C, S, LLC, LLP.   From a legal perspective and sheltering your risk from your personal assets, they are similar but for tax purposes there are significant differences. 

I am only discussing the tax differences as it relates to the selling of your company, not running your company.  Basically there is a significant fork in the road regarding taxes if you are a C corp vs all others types of entities (S, LLC, LLP).   The reason is that if you sell your C corp then the company must take the income from the sale and pay corporate taxes on the gains (approx 15% fed and 10% state) before any proceeds can be distributed to the owners.  Then, when the owners are distributed the proceeds of the corporate after tax money they are taxed again on their personal returns as a profit/gain.  This is considered a double tax and will cause a consolidated 50%-60% tax burden if not strategically handled.  That’s the bad news.

The good news is if you are a C corp and you can sell the stock of the corporation instead of it’s assets (usually very difficult and at a lower price) then you are taxed only at the individual tax level, just like the S, LLC, LLP.  This prevents the double taxation and thus more take home pay.  Now there are advisors that specialize in C corp transactions and say they have different ways to structure an asset sale of a C corp to minimize the double tax but they all seem a little risky to me. 

Now it is possible to change your entity type as to minimize this risk in the future.  The legal process is not difficult but the IRS is not going to let you go that easy.  Basically, if you change from a C to anything else to help minimize the double taxation, there is a 10 year tail where the IRS still requires the corporate tax step.  There are numerous strategies available to deal with this tail but you will need to find an advisor to help you.

The point here is that it is extremely important that you become aware that your entity type and that it does matter as it relates to the selling of your business.  Change is possible but you will want to do this asap and with some help.  Knowledge is power, so learn what your company is and make sure you are planning for your exit.

This entry was posted on Friday, June 12th, 2009 at 4:05 pm and is filed under Sell Your Business, Exit and Answers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.