Starting or selling a business? Remember taxes.

• Author: Helfand, Tom
• Position: Private companies

Unlike individuals, corporations do not benefit from a lower tax rate on their capital gains. Corporate capital gains are taxed like other ordinary income at a maximum federal rate of 35 percent.

So when a corporation sells all of its assets and then distributes the sales proceeds to its shareholders--who may be taxed on individual gains at a 15 percent capital gains rate--the effective tax rate can often be in excess of 45 percent.

On the other hand, if shareholders sell their stock--as opposed to the corporation selling its assets--there would be only one level of tax on the shareholders' gain, at the 15 percent capital gain rate. The total tax savings realized by selling stock instead of assets often is greater than 30 percent.

Most buyers prefer to purchase a corporation's assets rather than the shareholders' stock. When assets are purchased, the tax basis in the assets to the buyer usually increases to equal the purchase price paid.

The buyer will benefit from the future deductions made possible by this increased tax basis (as cost of goods sold, depreciation or amortization deductions). If the buyer purchases the stock, then the sold corporation retains the lower historic tax basis.

Intention of the 'Letter of Intent'

Consequently, in the initial "letter of intent" used to initiate a purchase offer, a buyer will usually specify the purchase of all of a corporation's assets instead of the stock.

Unfortunately, many shareholders who sell their companies will execute the letter of intent without recognizing the distinction and without considering the tax consequences of the asset sale, as opposed to a possible stock sale.

Though the executed letter of intent may not be fully binding on the seller, the terms of the letter tend to lock in the structure and pricing of a transaction and make renegotiation attempts difficult. The selling shareholders will be in a much stronger negotiating position if they are armed with the tax consequences and alternatives for structuring the transaction before executing the letter of intent.

Even if a corporate stock sale is unavoidable, there are other possible structures that might partially preserve a single level of tax of 15 percent at the shareholder level while at the same time permitting the buyer to receive an increase in basis in assets.

Sell Your Goodwill?

One alternative structure involves selling the personal goodwill of the shareholder. If a corporation is owned by a single shareholder and the...