When selling your interest in a business, you must consider several factors. One very important factor is taxation. Typically, you will transfer your interest in the business to others or to your corporation in return for cash or property. This will generally result in capital gain (or in some cases, dividends) or ordinary gains.
The tax consequences to you of selling your interest in a business depend on the type of business entity. The sale of corporate stock is usually taxed as capital gain or loss, although certain redemptions of your stock could result in dividend treatment. The sale of your interest in a partnership is also usually taxed as capital gain or loss, but certain payments for unrealized receivables and inventory items are taxed as ordinary income or loss. The sale of your interest in a sole proprietorship is treated as a sale of the assets of the sole proprietorship.
Note: Long-term capital gains and qualified dividends are generally taxed at 0%, 15%, or 20%, depending on the amount of the taxpayer’s taxable income. An additional 3.8% Medicare tax applies to some or all of the investment income for married filers whose modified adjusted gross income exceeds $250,000 and single filers whose modified adjusted gross income is above $200,000.
Although myriad business entities exist, the following types will be covered here: C corporations, S corporations, partnerships, sole proprietorships, limited liability companies (LLCs), limited liability partnerships (LLPs), limited partnerships (LPs), and professional corporations (PCs).
Impact on Specific Business Entities
Tax treatment will vary, depending on the type of business entity you select.
C Corporations
Generally, the sale of your stock in a C corporation results in a capital gain or loss. Thus, a sale to another person or an entity other than the corporation typically results in a capital gain or loss. However, a redemption of your stock by the corporation may be treated as a sale or exchange of the stock or as a dividend.
S Corporations
In general, the sale of stock in an S corporation is treated the same as the treatment of the sale of stock in a C corporation. Where the redemption of your stock by an S corporation is treated as a dividend, special rules apply if the S corporation has earnings and profits from before 1983 or from when the S corporation was a C corporation.
Partnerships
Generally, the sale of your interest in a partnership results in a capital gain or loss. However, certain payments for unrealized receivables and inventory items are taxed as ordinary income or loss.
Sole Proprietorships
A sole proprietor and his or her business are indistinguishable for tax purposes. Thus, the sale of a sole proprietorship is treated as a sale of the assets of the sole proprietorship.
Limited liability company (LLC)
Generally, the sale of an interest in an LLC will be determined in accordance with the partnership rules. The tax treatment of the sale of an interest in a one member LLC (if permitted by state law) will generally be determined in accordance with the sole proprietorship rules. The tax treatment of the sale of an LLC taxed as corporation will generally be determined in accordance with the C corporation rules.
Limited liability partnership (LLP)
The tax treatment of the sale of an interest in a LLP will generally be determined in accordance with the partnership rules.
Limited partnerships (LPs)
The tax treatment of the sale of an interest in a LP will be determined in accordance with the partnership rules.
Professional corporations (PCs)
The tax treatment of the sale of stock in a PC is treated the same as the treatment of the sale of stock in a C corporation. Keep in mind that the sale of an interest in a PC can usually only be made to another licensed professional or to the PC itself.
Caution: When considering any sale of an interest in a business, be sure to examine all relevant documents or laws for restrictions or conditions placed on the sale of your interest in the business. These might include the document creating the business, a stock certificate, a buy-sell agreement, a loan agreement, or state or federal laws. Restrictions or conditions might be placed on (1) who you can sell your interest to; (2) whether, when, or under what conditions you can sell your interest; or (3) the price that you can sell your interest for.
Managing a sale of a business to result in the best possible tax scenario can be extremely complicated. Qualified tax and financial professionals can provide valuable insight and guidance.1
- Working with a tax or financial professional cannot guarantee financial success. This material has been distributed for general educational/informational purposes only and should not be considered investment advice, tax advice or legal advice, or a recommendation for any particular security, strategy or investment product.
Prepared by Broadridge Advisor Solutions. Edited by BFSG. Copyright 2022.
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