BLOG: Introduction to taxation of sale proceeds: S corporation
Click Here to Manage Email Alerts
Our next post in this series addresses the taxation of sale proceeds if a target practice is classified as an S corporation.
Below we provide a high-level summary of the U.S. federal income tax treatment of a sale of assets by an S corporation vs. a sale of stock of an S corporation. State and local tax consequences must also be taken into account, which add nuances that need to be fully considered on a case-by-case basis. The tax consequences of a sale of a medical practice are complex, and it is important to consult with your tax adviser early on in the sale process.
Source: Adobe Stock.
Stock sale: As with a C corporation, each shareholder generally will recognize gain or loss equal to the difference between the portion of the purchase price received and the tax basis in such shareholder’s stock. Such gain or loss generally will be long-term capital gain or loss to the extent the selling shareholder held the stock for more than 1 year. Long-term capital gain recognized by an individual currently is subject to U.S. federal income tax at a maximum rate of 20%, and short-term capital gain currently is taxed at a maximum rate of 37%.
Asset sale: The S corporation generally will recognize gain or loss with respect to each asset equal to the difference between the amount of the purchase price allocated to such asset and the tax basis of such asset. Such gain or loss will be capital or ordinary depending on the type of asset. However, unlike a C corporation, an S corporation generally is not subject to U.S. federal corporate income tax on such gain, subject to certain exceptions (eg, if the practice is a former C corporation that converted within the past 5 years). Instead, each shareholder is subject to tax on his or her pro rata share of any gain recognized by the S corporation. A substantial portion of the purchase price tends to be allocated to goodwill or other capital assets, and thus, a substantial portion of the gain being allocated to the shareholders tends to be capital gain. Furthermore, sale proceeds generally can be distributed out to the shareholders without additional U.S. federal income tax.
Unlike with a sale of C corporation stock, the 3.8% net investment income tax generally does not apply to gain recognized on a sale of S corporation stock or gain allocable to a shareholder from a sale of the assets of the S corporation to the extent the relevant shareholder “materially participates” in the business of the S corporation.
Observations: It is common for an entity owning a medical practice to be classified as an S corporation, although practices can be classified as C corporations or partnerships. Unlike an asset sale by a C corporation, an asset sale by an S corporation generally does not result in two levels of U.S. federal income tax and, thus, generally is an acceptable structure for both buyers and sellers. Note that it is possible to achieve the U.S. federal income tax results of an asset sale without actually selling the assets of the S corporation if the parties to the transaction make certain tax elections or engage in certain pre-closing restructuring transactions.
Collapse
Read more about
Click Here to Manage Email Alerts