Imagine a buyer has just acquired your C-Corp in an asset purchase. You pay tax on your gain on the sale and then distribute the remainder to your shareholders. But wait – your shareholders now have to pay tax on the dividend. You probably hold the most equity, so you effectively get taxed twice for the same event. Doesn’t seem fair, does it?
Your sense of injustice is spot on here. Riding the startup train to exit requires years of immense tenacity and focus. If an asset purchase means losing thousands or even millions due to double taxation, you might be clenching your fists instead of popping a cork. When Benjamin Franklin said taxes were inevitable, I’m sure he wasn’t thinking of double taxation.
Thankfully, you can avoid double taxation in various ways. The simplest solution is selling your stock, not your assets. Buyers generally try to avoid this, however, as it means acquiring potential liabilities such as contract disputes, lawsuits, product warranty claims, and so on. They’ll push for an asset sale, and if that’s the only route to exit, you might have to consider it.
Before we explain how to avoid double taxation, you must first understand the differences between corporate entities and how they’re taxed.
Corporate Forms and How They’re Taxed
In the United States, the three most common corporate forms are an LLC taxed as a partnership, a corporation that has elected to be a small business corporation (an “S Corp”), and a C Corp, which is generally any for-profit corporation that has not made its S-Corp election.
LLCs and S-Corps are “pass-through” entities, meaning that income of the entity is passed through to its owners, and the owners personally pay taxes on income they receive as a result of their ownership. As a result, LLCs and S-Corps avoid taxes at the stockholder and membership level, so an asset or share sale wouldn’t normally result in double taxation.
C-Corps, however, are not pass-through entities. Although they have some advantages over LLCs and S-Corps (for example, ease of taking investment and Qualified Small Business Stock), they’re taxed at both the stockholder and personal level. If you’re the founder of a C-Corp and a major shareholder, you will probably pay taxes twice if you sell your assets rather than stock.
How? First, you pay taxes on the taxable gain from selling the company’s assets (taxation at the stockholder level). Then, assuming you’ve wound up the company, when you distribute proceeds to your stockholders, they will pay tax on the amount they receive as a dividend (taxation at the individual or personal level). And who owns the most equity? You.
For this reason, most of the time, it is generally preferable that you don’t get Acquire’d in an asset purchase if you’re currently organized as a C-Corp.
How to Minimize Tax on an Asset Sale (as a C-Corp)
When you decide to sell your startup, you want it to happen quickly. The longer it takes to sell, the longer you have to wait for that next chapter, whether that’s a new business or some much-needed rest or retirement. You might also be a bit anxious about turning offers down – will you get another just as good?
I can’t decide that for you, unfortunately, but you should try to get what you want from the acquisition (within reason). An asset purchase could be a worthy trade-off if the buyer is insistent, or you simply want to carve out one component of your business – and there is at least one method you can use to minimize any adverse tax consequences.
Purchase Price Allocation
How you and the buyer allocate the purchase price in an asset acquisition impacts the tax you pay. A good M&A attorney and CPA can help you determine an allocation that avoids paying higher tax, thus adding financial value far greater than any fees you pay for their services.
An example of purchase price allocation is allocating some of the purchase price towards any non-competition covenants of the seller (you or your employees) or goodwill of the company, rather than to the actual assets that are purchased in the transaction (e.g., your code, domain, or any other assets). This might result in paying lower taxes overall.
However, deal structures and purchase allocations are complex areas in which you need the expertise of an M&A attorney or CPA, so we strongly recommend consulting with one or the other whenever you first receive a Letter of Intent (LOI) or term sheet. The further your acquisition progresses, the harder it is to walk away from the deal, so consider the tax implications of an asset purchase as soon as a buyer shows interest.
To minimize the tax on your acquisition, consider hiring one of our approved advisors from the M&A Advisor Directory. With over 50 seasoned advisors to choose from, covering everything from M&A to tax to legal, you’ll easily find someone who can help minimize or eliminate the tax liability on your acquisition. Visit the M&A Advisor Directory now.
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