S Corporation Rollover Equity – Involve Your CPA Early and Often

When selling your closely held or family-owned business, there are often multiple structures that warrant consideration.  Should you sell your assets or your stock? Should you defer a portion of the purchase price?  What are the tax consequences?  Should sellers retain equity?  How is retained equity taxed?  Each of these items should be carefully considered in the beginning phases of negotiation, and your CPA should be involved in these discussions in order to achieve the desired after-tax cash outcome of the selling parties.

In particular, when a business is owned and organized as an S Corporation for tax purposes, there may be certain goals that are more difficult to achieve due to the limited flexibility with regard to ownership and allocation of income and distributions required by the S Corporation rules.  Generally, to qualify as an S Corporation, the entity must have only one class of stock that confers identical rights to distributions and liquidation proceeds.  One situation where this requirement may cause added complexity to a sale is when an ownership group includes multiple generations of a family with some members more involved in the business than others and key executives being required to roll over more equity into the proposed post-transaction structure than other members have been asked to or desire to roll over.  When the target is either a Qualified S Corporation Subsidiary or Single Member LLC and rollover equity in the post-transaction structure is held by the parent S Corporation rather than the individual shareholders, there may be a need enter into redemptions of certain shareholders or share purchases between shareholders.  The goal of disproportionate rollover equity becomes even more complicated in this situation when you have potential earn-out payments to be made in the years following the initial closing date. 

It is important to involve your CPA in early discussions between investors or family members when deciding or formulating the goals of a potential sale.  Your tax advisor should have an in-depth knowledge of the current structure and history of the company and your shareholders to help guide management regarding the possibilities and opportunities that are available and the associated complexity as the transaction is negotiated.  Generally, there will be planning opportunities available to achieve many, if not all, of the goals of the selling parties.  It is crucial to identify transaction complexities early in order to inform the advisory team, including investment bankers and attorneys, as they assist with the negotiation of terms of a sale.  It is equally important to be able to set appropriate expectations with selling shareholders and avoid surprises as the closing date approaches or, even worse, managing post-close tax planning related to the transaction. 

If you are considering a potential sale of your company, a Schneider Downs Succession Planning advisor will be able to assist you and your family or investor group in navigating these complex tax issues when negotiating the terms of your sale.  Please contact Schneider Downs and allow us to start a conversation with you regarding these matters.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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