Eyeing the Sale Block?

With a new tax year beginning, a sole proprietor considering selling his business has a fresh year to groom the venture for sale. Certified public accountant Walter Miller consults for Jones Jones & Doss, a Fayetteville tax law firm, and he said there are a few tax options sellers should consider.

Miller said, sellers should start by hiring legal and tax advisers to help sort the company’s paper documentation and suggest organizational improvements. Generally, the counsel will lead the seller through owner due diligence — methodical straightening of the business’ organization and operation.

Most buyers hire counsel to inspect a target corporation, so examining all of the company’s records thoroughly can help catch problems before the buyer’s team finds them. Everything from vendor contracts to payrolls should be ready for the buyer’s inspection.

Sellers may also want to consider changing the company’s organization, Miller said. Because the value of a business is usually determined by its profits, the seller should try to increase the company’s revenue and minimize its expenses. To do that, he said, a sole proprietor might benefit from becoming an “S” corporation or a limited liability company.

S-corps have 75 or fewer shareholders, enjoy the benefits of incorporation, and are only taxed once per year. Corporations are entities separate from their owners.

S-corps can also save on Federal Insurance Contributions Act (social security) payments, Miller said, because they aren’t subject to self-employment taxation like sole proprietorships. The corporations must pay “reasonable” wages to the owners, but Miller said they can save up to 15 percent of profits.

Hypothetically, he said, if a business makes $50,000 in profits after paying owner wages, it can save up to $7,500 per year in self-employment tax.

S-corps also have the option of selling a portion of the business as part of the company’s stock. Business owners often give or sell some stock to family members who will succeed them in running the company.

S-corps can also sell or offer stock as compensation for employees.

Sole proprietors with a growing business should consider becoming a limited liability corporation, Miller said. LLCs receive the same owner-liability protection as an S-corp, but they are run under more liberal tax rules.

Miller explained two additional reasons for forming an LLC.

First, LLCs can offer different classes of ownership, including preferred or common, voting or nonvoting and income only or capital only.

Second, LLCs are allowed to make special allocations for profits and losses to particular members or owners of the company.

Miller gave the example of a father and son who wanted to form an LLC to run a company. The father agrees to put up the money for the venture, while the son pledges to perform the services. Although the father and son will eventually share the LLC’s profits equally, they allocated in the operating agreement that the business’ profits will go to the father until his contributed money is paid off.

When a company is sold, Miller said, its owner usually wants to sell an S-corp’s stock or assets or an LLC’s membership interest or assets.

However, a buyer typically wants to purchase a company’s assets.

If the buyer purchases the company’s stocks or interest membership, he becomes responsible for all known and unknown liabilities. In those cases, hidden bookkeeping problems, such as those rendered by IBP Inc. during the recent Tyson Foods Inc.-IBP acquisition, become the buyer’s issue.

Miller said both buyer and seller should beware because they have opposing taxation interests for the acquisition.rElisabeth Butler may be reached at [email protected].