Sellers: chose carefully to maximize after-tax cash flows.

• Author: Corrente, Michael F.
• Position: Private companies

Deal structure is important in any effort to maximize after-tax cash flow on behalf of a seller. Reducing the number of levels of federal income tax imposed on profits the seller derives from the transaction is key and is tied to both the structure of the company--whether it is organized as a Subchapter S, Subchapter C, LLC or other type of company--and to the structure of the deal itself.

Regarding the organization of the business, it is critical to explore who must pay tax on profits derived from the sale--the company itself or just its owners. Though exceptions abound, if a business is set up as a Subchapter C corporation for federal income tax purposes, for example, it generally must pay tax on its profits before they are distributed to shareholders, who then typically must pay tax themselves upon receipt of any profits. This constitutes two levels of taxation.

Conversely, Subchapter S corporations generally do not pay tax on profits. Instead, the profits are taxed on a flow--through basis only to shareholders, a practice that represents only one level of tax.

Structures for Taxable Transactions

Often, sellers are so narrowly focused on the purchase price they do not step back and consider the importance of the overall deal structure. However, properly structuring a transaction is as critical to a seller's efforts to reap maximum value as is negotiating valuation. Therefore, the goal is to structure a transaction in such a way that the seller faces as few levels of tax on profits as possible. In order to determine the most beneficial structure, a seller must consider three key questions when exploring any potential deal:

1. Does the transaction involve a single or double level of tax?

2. Will I receive capital gains treatment on this transaction?

3. When will I receive cash from this sale--immediately, or is it deferred?

Some typical transactions and brief discussion of tax considerations follow:

* Stock Sale. From a tax-planning perspective, selling stock, rather than assets, affords the seller the greatest financial advantage. A stock sale is subject to a single level of tax at the current federal rate of 15 percent on long-term capital gains, assuming the seller has held the stock for more than 12 months prior to the transaction.

To mitigate risk and preserve value, the value of this stock can be locked in, using devices such as puts, options and collars, for example. An additional benefit of a stock sale is that the seller does not...