Business Formation, Purchases & Sales — explore related guides and services.
The buying and selling of a business is one of the most important events in the life of a business person. The financial success or failure of the purchaser or seller of a business frequently depends upon his or her lawyer’s and accountant’s familiarity with the tax consequences of their transactions.
It is the lawyer’s and accountant’s responsibility to his or her client to be knowledgeable concerning the tax and other legal and financial ramifications of his or her client’s transaction. For the attorney representing the seller, the after-tax dollars that the seller can retain after the sale are of vital importance. For the attorney representing the purchaser, the future success of the purchased business could depend upon the net dollars available to the business after payment of expenses and taxes.
In both situations, the lawyer’s representation and advice concerning the original transactions, especially the initial contract of sale, will determine the future tax consequences.
A business sale can produce gain, loss, compensation income and other tax consequences. The result depends on the entity’s tax classification, assets or interests transferred, consideration, liabilities, payment schedule and any applicable nonrecognition rules. A buyer’s basis, cost recovery and elections also require analysis. A rollover or reinvestment does not establish tax deferral merely by its label.
A business can be operated as an individual proprietorship, a partnership, or a corporation. If the business is a corporation, it might be a Subchapter S corporation, that is, a corporation which has elected not to be taxed upon its corporate income, but to have that income taxed directly to its shareholders.
Check our blog post on new entity EIN and Tax classification.
Sale of Sole Proprietorship
- A proprietorship, for tax purposes, is not an entity separate and distinct from the individual who owns it and has no separate existence.
- The sale by an individual of a proprietorship business is the sale of the individual assets of the business. The seller will recognize and be taxed upon the gain or treat as a loss an amount based upon the difference between the amount he receives for each individual asset of the business and his tax basis in each of these assets.
- The nature of his gain or loss, capital or ordinary, will depend similarly upon each individual asset comprising the business
Sale of a Partnership or LLC Interest
A sale of a partnership interest is generally a sale of the owner’s interest, rather than a direct sale of the partnership’s individual assets. Gain or loss depends on the amount realized, including applicable relief from partnership liabilities, and the seller’s adjusted outside basis.
Under §741, gain or loss is generally capital, but §751 provides ordinary treatment for the portion attributable to unrealized receivables and inventory. Unrealized receivables can include specified depreciation-recapture amounts. The seller therefore needs information about the partnership’s assets as well as the owner’s basis. See IRS Publication 541.
A domestic multi-member LLC generally defaults to partnership taxation unless it elects corporate treatment. A single-member LLC generally defaults to disregarded-entity treatment. Confirm the actual tax classification before applying partnership rules.
Compare an LLC member buyout structured as a sale or redemption. For an exit without consideration, review abandoning a partnership interest instead of selling it; actual or deemed distributions, including liability relief, can change the loss treatment.
The supporting calculations include outside basis versus K-1 capital, partnership debt relief, and suspended passive losses on exit.
Sale of a Corporation
A corporate transaction may involve a shareholder stock sale, an asset sale by the corporation, or another structured acquisition. A stock sale generally measures the shareholder’s gain against stock basis; an asset sale measures gain or loss at the corporate level by asset, with any later distribution requiring its own analysis.
A C corporation asset sale followed by distributions can create tax at both corporate and shareholder levels. S corporation treatment differs and can involve pass-through gain, basis adjustments and, in applicable cases, built-in gains tax. Review the actual classification and election history rather than assuming every corporation has the same result.
Price allocation, assumed liabilities, contingent payments and available elections affect both parties. See IRS guidance on selling a business. Model the proposed structure before signing binding terms.
Tax is the center of sale of a valuable business. We can structure the sale by providing tax counsel or we can represent you during the entire course of the transaction including contract drafting to closing.
Major transactions should be modeled before contracts and tax positions become fixed. Our tax strategy and planning service can address transaction structure, entity choice, basis, gain recognition, and the interaction between business and individual taxation.
Typical tax returns for businesses include Form 1065 for partnerships, Form 1120-S for S corporations, Form 1120 for C corporations, and Schedule C for sole proprietorships. See our business tax preparation service for coordinated entity and owner return filing.
See also our page on Real Estate
Stock Exclusions and Acquisition Funding
When negotiating a corporate stock sale, review Section 1202 QSBS eligibility and Section 1045 planning. For buyers using retirement assets, ROBS business funding requires a separate review of plan ownership, valuation, and the acquisition structure.
Management Compensation in a Business Sale
A company transaction can change an executive’s ownership, phantom benefits, bonus rights and future services. Review executive equity, transaction bonuses and rollover planning alongside the broader deal. Compensation, purchase price, severance and new investment rights may have different tax treatment.
Related Business Legal and Tax Services
Business decisions often involve overlapping legal, tax, financial-reporting, ownership and entity-structure considerations.