C Corp acquired by a LLC
December 28, 2020
by a searcher from Harvard University - Harvard Business School in Fort Wayne, IN, USA
In my hunting, I found a crazy deal. The owner really, really likes me, is tired of running his business, and proposed the following deal: I buy his company from him for $10M (~$6M in EBITDA), but instead of using investors, I would just pay him anything over my salary and taxes until I hit the $10M price tag (~3-4yrs). He moves to Chairman and me to CEO. Equity swap would happen at close.
The business is a C Corp, and he's asking me how he can reduce his tax burden so he can keep as much of the $10M as possible.
Does anyone have any creative ideas on how I can save him taxes on this sweetheart deal?
Thank you. Happy New Year!
from Rensselaer Polytechnic Institute in Connecticut, USA
First, great find and congrats!
Idea #1: Qualified Small Business Stock
Confirm if the stock sale qualifies as a Qualified Small Business Stock (QSBS). Section 1202 of the Internal Revenue Code allows the Seller to avoid federal taxes on capital gains when they sell stock of a C-corporation. The exclusion is capped at the greater of $10 million, or 10 times the amount paid for the stock. Further benefits include elimination of the Alternative Minimum Tax and the Net Investment Income Tax against the sale proceeds.
For the business to qualify, it must be a C-corp with less than $50 million in gross assets at the time (or immediately after) the original stock was issued. The business must also not be involved in any trade or business where the principal asset is the reputation or skill of one or more of its employees (i.e. a service business). Other excluded businesses include restaurants, banks, hotels and farming.
If the stock qualifies under Section 1202, it's a done deal. No federal tax is payable.
Idea #2: Installment Sale
The scenario you describe is a classic installment sale. The Seller can sell up to $5M per year of assets under an installment sale and not have to pay extra penalties to the IRS. He could sell you $5M in2020 and another $5M in January of 2021 to avoid this penalty.
Regardless, he'll pay taxes on the sale of the business each year he receives the payments from you. This should knock some of his recognized gains into lower tax brackets. There will be a savings. However, each installment will have to include some interest payments which are taxed at ordinary rates. Still, it's a win for him.
Idea #3: Consulting Contract with a Defined Benefit Pension (DBP) Plan
A DBP is a pension program that a company manages for its employees. If the Seller were to stay on as a consultant to the business and receive a consulting fee through an LLC or an S-corp, he could set up a DBP for himself and save up to $250K/year tax-deferred. This money could then grow tax free until he pulls the funds out. They are taxed at that time as ordinary income. This may/may not be ideal since the sale of the C-corp is likely to be taxed as capital gains.
Idea #4: Opportunity Zones
There's a ton of into on these, but he can dump the payments into an opportunity zone fund and invest in real estate or other qualifying businesses. The tax benefits are significant - if you can find the right roll over investment.
You can mix and match these ideas depending on the situation. I also have a draft whitepaper titled "8 Ways to Avoid Taxes When Selling a Business" .. the final version should be ready in a week or two. Reach out to me and I'd be happy to share it with you.
Good luck,
Adam
from Indiana University at Bloomington in Carmel, IN, USA