Take a moment for “Bits & Bytes,” as Attorney Tom Schumacher explains succession planning for the owners of a closely held business. This third installment discusses the different legal structures of a business entity.
Disclaimer: This video is designed to be educational and informative, but it is not legal advice. Business, tax and estate planning law is constantly evolving and subject to change. Each situation is unique, and each case should be addressed to fit the unique situation.
If you have successfully operated your business for a number of years, it already has a legal structure. This may vary from a sole proprietorship to multiple related entities owning various aspects of your business. For example, one entity may own the real estate in which the business operates.
A separate entity may be the actual operating entity of the business. Another entity may own specific intellectual property. Each business entity has unique legal and tax aspects which play a role at the time you decide to proceed with a transfer of your business.
Some entities are ignored for income tax purposes such as a sole proprietorship or a single member limited liability company. C Corporations, on the other hand, are separate taxable entities that file their own tax return separate from the return of the owner.
The structure of your business entity will be a key factor when it comes time to transfer your business. Many operating businesses today are organized as corporations or limited liability companies. Most sales of closely held businesses are asset sales and not stock or membership sales.
This means that the third party buyer will buy the assets of your business and not the stock. There are a number of liability and tax reasons for a buyer to acquire assets and not the stock of your corporation. The result of an asset sale is that the proceeds go to your business entity and not to you individually.
Your business entity will pay income taxes on the sale of the assets. Whether or not you can distribute the proceeds from your entity to you without paying additional taxes will depend on the tax structure of your business entity. C Corporations have a double tax, one at the time the assets are sold by the corporation and a second tax when the proceeds are distributed as dividends to you, the owner.
Because of this double tax, many business owners elect to have their company taxed as an S Corporation. This means that the income of the corporation is not taxed to the corporation but, rather, is passed through to the owner who then pays taxes on the income. If you have a C Corporation, early planning may allow you to make an S Corporation election that will save you a considerable amount of tax dollars upon the sale of your business.
Any buyer of your business is going to want to review your business organizational documents, record books and minutes as part of their due diligence process. They will also want to review any significant contracts the business has with third parties. Another area that they will explore is the salaries and benefits of your employees.
It is important to have complete and accurate records regarding your various insurance plans for workers compensation, general liability, health and disability. If you have an employee retirement plan, the buyer will want to review these documents as well. As an owner who is looking at a potential business transfer, all of these records should be organized and up to date.
Business records are critical to any business succession plan. It is never too early to begin to review and organize these records.