Sell (or Buy) a Corporate Business With a Tax-Free Reorganization

There are two basic ways to sell an incorporated business — sell the assets or sell the stock. For two good tax reasons, sellers usually prefer stock sales:

  1. Assuming you’ve owned the shares for more than a year, your profits will generally be taxed at a maximum federal rate of 20 percent.* This applies equally to C and S corporations.
  2. Double taxation is avoided when you sell C corporation stock, because the sale won’t trigger any taxable gain at the corporate level.

However, there may be an even better alternative. If you can find another corporation to acquire your C or S corporation, you may be able to structure the transaction as a tax-free reorganization. How? You swap the stock in the company being sold for stock in the purchasing corporation. There is no current taxable income or gain for you, the target corporation you’re selling or the acquiring corporation.

Here are the basic advantages of this strategy:

  • You exchange your stock in the target C or S corporation for stock in the acquiring corporation. Your new shares will have the same tax basis as your old shares. In addition, you don’t have to report any taxable gain until you actually sell the shares. Result: The tax bill is put off indefinitely.
  • When you do finally sell, the long-term capital gain will be taxed at a maximum federal rate of 20 percent.*

If you die while still owning the shares, the tax basis will be stepped up to fair market value as of the date of death. So your heirs can sell the stock and owe little or no federal capital gains tax. (This assumes the current date-of-death basis step up rule remains in force.)

There is a small glitch for the buyer: With a tax-free reorganization, the corporate buyer cannot step up the tax basis of your corporation’s assets. However, the buyer may be willing to overlook this issue when the acquisition can be made with stock rather than cash.

A tax-free reorganizations can potentially be structured in several different ways, including as a state-law merger, straight stock acquisition, or asset acquisition. The best structure for your corporation may depend more on legal considerations than tax issues.

The optimal scenario for a tax-free reorganization: You receive investment-grade publicly traded shares in exchange for your stock. This would give you great tax benefits but also a high-quality and highly liquid asset. Tax-free reorganizations are complicated so it is important to have an experienced professional handle the transaction. Contact your attorney for more information.

*Note:The 20 percent rate only affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000, heads of households with income above $425,000, and married individuals who file separate returns with income above $225,000. Capital gains on investments held less than a year are short-term capital gains and taxed at ordinary income tax rates of 10, 15, 25, 28, 33, 35, or 39.6 percent.

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