1. Selling Stock vs. Selling Assets
2. Capital Gains Taxes on the Sale of an S Corporation

Updated July 15, 2020:

Selling S Corp stock can be a very involved process and may require you to pay capital gains tax after your stocks have been sold. 

Selling Stock vs. Selling Assets

When establishing their company, many business owners choose to form a corporation covered by the Internal Revenue Code Subchapter S. This may make the company eligible for an election.

Forming a business in this manner provides corporate-level asset protection and also allows the business to be taxed as a pass-through entity. Despite this benefit of being a pass-through entity, there are considerations related to taxes when selling an S Corporation. For instance, in terms of taxes, you must be careful about how you are structuring the sale of your S Corporation.

Essentially, to sell your S Corp, you have two options:

  1. Sell your S Corp stock.
  2. Sell your corporate assets while retaining the corporate structure.

Selling stock is the easiest method of structuring an S Corp sale. If you choose this solution, you will deduct the money received by the owner of the business from selling the stock from the S corporation share tax basis.

While it can be difficult to calculate a tax basis in an S Corporation, the basis of the business owner will typically be calculated based on how much capital the owner contributed to the company. You may need to make adjustments for:

  • S Corporation revenue that has been generated
  • The distributed profits the owner withdrew from the company

When the amount of money earned from the sale of stock is more than the owner's tax basis, the owner will need to pay capital gains tax for the sale.

There are multiple steps required when choosing an asset sale instead of a stock sale. For example, every asset that is being sold will need to be assigned a tax basis by the business owner. After this, the purchase price will need to be allocated. Depending on the assets sold, the beneficial capital gains tax may not apply to gains from the sale. If an asset does not have a tax basis, then gains from the sale will be subject to income tax rates instead of the capital gains tax. Also, if you are selling equipment that has depreciated in value, you may need to pay recapture-rates that may be higher than normal. This can result in the business owner paying higher taxes than they might otherwise.

To reduce the tax burden, it is usually preferable to sell an S Corp by selling stock instead of assets. However, people buying an S Corp may prefer an asset sale, as this type of sale can provide advantageous deductions for appreciation and may allow for a basis reset.

In certain situations, a tax provision can allow parties involved in the sale of a company to treat a stock sale the same as an asset sale. However, this usually requires advice from experts, as it can be very complicated. 

The sale of an S Corporation can be the final step in the successful development of a business. However, when selling your corporation, it's important to make sure the taxes are handled correctly so that you can maximize your profit after taxes. 

Capital Gains Taxes on the Sale of an S Corporation

The income earned by an S Corp is passed through, which means shareholders of the company will report this income in their personal tax returns. Similarly, when an S Corp is sold, the proceeds of the sale are passed through. The difference is that sale proceeds are not reported as ordinary income but as capital gains. This is according to the rules of the Internal Revenue Service.

The stock basis will determine an S Corporation's capital gains tax.

According to the IRS, a stock basis is your total capital investment in the corporation. Generally, this is how much you paid for:

  • Services or property
  • Debt
  • Cash

How undrawn profits are distributed can change your stock basis. For example, if your S Corporation undrawn profits are $50,000 in a single year, your stock basis will increase by the same amount. This increase is considered tax-free because you should have already reported and paid for these taxes on your return. This is true whether or not you have been given the money.

If you need help selling S Corp stock, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.