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C-Corp Asset vs. Stock Sale Dilemma

Jan 29, 2008
Shareholders of C-Corps often experience significant anxiety when it is time to exit their business. If they are fortunate, they will exit by way of a stock sale. In these cases, their Corporate Tax is $0 and then when the proceeds are distributed to the shareholders, the capital gains taxes will be approximately 20%.

To minimize future taxes and third party liabilities, the majority of buyers prefer to purchase selected assets of the seller rather than its stock. The total taxes associated with the asset sale of a C-Corp is typically more than 50% of the corporate gain (i.e. approximately 40% of the gain over the basis is taxed at the corporation's income tax rate. The gain often drives that corporate rate to the highest level because the gains are treated as ordinary income by the corporation. When the remaining funds in the C-Corp are distributed to the shareholders, they are taxed again at the individual shareholder's capital gains tax rate, normally 20%.

In many cases, C-Corp shareholders receive offers for asset rather than stock sales. Due to the huge tax implications discussed above, the sellers often reject an offer at current fair market value because the net after tax proceeds from the transaction is too low to meet their personal financial requirements. The C-Corp then asks for a higher price and negotiations stall.

How C-Corp Shareholders Can Increase Their Net Gain After Taxes

There is a solution to this dilemma that enables the shareholders of the C-Corporation to increase their net gain after taxes significantly from an asset sale. The following is a summary of how this strategy works.

C-Corp shareholders sell the operating assets of the Company to an asset Purchaser at the negotiated fair value.

C-Corp shareholders leave the cash proceeds from the asset sale inside the Company.

Then, C-Corp shareholders sell the stock of the Seller to another purchaser (Stock Purchaser) in an independent transaction that does not involve the original Purchaser in any way.

In such a transaction, the Stock Purchaser pays the C-Corp shareholders cash upon closing of the stock sale and the Stock Purchaser assumes the ongoing liabilities of the Company, including the corporate tax liability (approximately 40% of the corporate gain) from the sale of the assets of the Company. The shareholders, relieved of the corporate gain liability, are now only responsible for paying the capital gains tax, approximately 20%, on the proceeds received from the Stock Purchaser from sale of the stock.

The transaction works because the Stock Purchaser is in a position to shield the gain from the asset sale with solution assets from other operations. Subsequent to the sale, the Stock Purchaser re-engineers the Seller into a new line of business that is expected to be profitable.

As the new owner of the Seller, the Stock Purchaser is responsible for running the Company on an ongoing basis and satisfying the current and future corporate tax liabilities of the Seller.

Here is an example of how it works:

Let's assume the corporate gain resulting from a C-Corp asset sale is $10M. The shareholders would typically net approximately $4.8M after taxes (in most states) after paying taxes on both the asset sale and the personal capital gains taxes upon distribution of sale proceeds. Utilizing the solution described above, the C-Corp shareholders could net as much as $6.4M after taxes. This represents a gain in take home cash of more than 30% as compared with the traditional asset sale scenario.
About the Author
Dave Kauppi (davekauppi@midmarkcap.com) is the editor of The Exit Strategist Newsletter, a Merger and Acquisition Advisor and President of MidMarket Capital, representing owners in the sale of privately held businesses. We provide Wall Street style investment banking services to lower mid market companies at a size appropriate fee structure.
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