S corporations and LLCs are pass through entities, which means that the corporation or legal entity’s income is passed through directly to stockholders or members.  Consequently these entities do not pay income taxes, the owners receive the income and they pay the taxes.  

 

C corporations are different. C corporations retain the earnings (income), pay taxes on the income and then distribute dividends to the shareholders.  In day to day operations this is not a big deal. You very likely have a salary and benefits which reduce the taxable income to the corporation and you CPA is probably working hard to minimize your taxes.  But when you go to sell your C corporation you could be in for a big tax bill. 

 

When you sell your C corporation it will very likely be an Asset sale, which means that the buyer will purchase the assets of the company from the corporation and the proceeds will go to the corporation.  The corporation recognizes this “income” and is taxed on it, and then when you pull the cash out of the corporation you are taxed on it again!

 

That’s right; if you are not careful you could pay double taxes when you sell your company if it is a C corporation.  There are ways to minimize the taxes on the sale of your business, even if it is a C corporation.  In some cases a Personal Goodwill transaction structure may be applicable which substantially reduces the taxes in the sale of a C corporation.  In other cases your CPA or financial planner may be able to develop tax strategies to substantially reduce your tax liability. There are advantages to C corporations, but when selling a C corporation you must plan in advance. 

 

The key is that if you own a C corporation and you are thinking about selling your company in the next few years you should meet with your professional advisors to start developing your Exit Strategy.  You should meet with your CPA and your VR professional intermediary to start developing your exit strategy well in advance. It will pay big dividends in the form of reduced taxes, potentially an increased market value by preparing the business for sale in advance, and a more marketable company.

 

We will talk about Stock vs Asset sale transactions next time.