Last month I pointed out that there are significant disadvantages to forming what is called a C Corporation. That’s what most of us think of as a regular corporation, a corporation that files tax returns for its own income and losses and pays taxes at a corporate rate, not an individual rate.
One of the problems I pointed out was that a C Corporation is unable to distribute appreciated assets without tax complications for both the corporation and its shareholders. A reasonable comment I have heard on this warning is that people don’t plan to distribute assets out of the corporation. Once they put them in there they expect them to stay there. Therefore, why worry about distributions?
The first response to this is that you need to be careful about what you put into a corporation in the first place. There are a great many reasons, for example, why you would like to have real property held separate from the dealership operations. I have discussed this in a previous blog.
If you put only essential assets into the corporation to start with, then you will probably not have very many reasons to take them back out, although if you have practiced law as long as I have you see lots of unusual situations arise. Nonetheless, there is one big issue about taking assets out of the corporation. Sooner or later, most businesses are sold. When you sell a business a buyer usually does not want to buy your corporation; he wants to buy the assets of the corporation.
There are two good reasons for this. First, when someone buys a corporation, he buys any problems it may have. These problems include things like pending lawsuits, licensing problems and undisclosed debts. The second and bigger reason why a purchaser does not want to buy corporate stock is that typically he gets better tax treatment when he buys the assets. Most corporations have a value greatly in excess of their tax basis in their assets. The difference between this excess value and the tax basis is usually treated as “goodwill” which for tax purposes is an intangible that a buyer can write off for over a period of 15 years. If the buyer buys corporate stock, he has few opportunities to get tax credit for the amortizable good will. Therefore, a purchaser of corporate stock is likely to pay higher taxes for the next 15 years then if he had bought corporate assets.
So when you get ready to sell your corporate business, you will find the buyer wants to buy the assets, not the stock, and if you let him do that you will have that double tax problem. First the corporation will pay taxes on its taxable gain, and then it will distribute the after tax proceeds to you and you will be taxed a second time.
A Subchapter S Corporation is therefore often preferable to a C Corporation for tax purposes, and a limited liability company may be even better.
This blog is a highly simplified general discussion. It is not legal advice. Such advice should come solely from qualified legal counsel who understands your situation and who is familiar with all relevant facts, variations in state and local laws that may apply to you, and other matters beyond the scope of this blog.