Buying or Selling a Business in Maryland, DC, or Virginia
Buying or selling a business in Maryland, Washington DC, or Virginia can be a complicated process. There are numerous legal decisions which must be made by the both the seller and purchaser, and many different legal and tax ramifications of each type of purchase transaction. One of the initial decisions that buyers and sellers will face is to choose the type of transaction: (1) a stock purchase (membership purchase) or (2) an asset purchase.
In most cases, when selling a business, a seller will prefer to sell the stock or membership interest of the business; while the purchaser will prefer to buy the assets of the business. In Maryland, Virginia, and DC, these two different transactions are beneficial for the parties for different reasons ranging from liability to tax planning.
In Maryland, Virginia, and Washington DC, sellers generally benefit from selling the stock or selling the membership interest of the business. This type of transaction arrangement benefits sellers because the transaction generally reduces the taxable gain the seller will recognize, which will help to reduce the taxes paid by the seller on the transaction. The seller will most likely recognize capital gain on the sale of the stock or membership interest. However, the specific seller’s tax bracket will determine whether a stock sale or membership-interest sale is beneficial.
Nonetheless, when selling an entity that is taxed as a C Corporation, it will generally be advantageous to conduct a sale of the entity. The reason why a sale of the entity is beneficial for the seller in this situation is due to the issue of double taxation when a C Corporation sells its assets. When the owner of a C Corporation sells the assets of the C Corporation in Maryland, Virginia, or DC, the entity itself will recognize a gain on the sale of the assets. The C Corporation is then taxed on that gain. When the corporation makes a distribution to the shareholder, the shareholder will then recognize income on the distribution; hence, double taxation –where the corporation pays a tax and the shareholder pays a tax on the same income. Depending upon the income bracket, this transaction method can reduce the realized total amount of the sale by more than forty percent.
In order to avoid double taxation upon the sale of an entity, the seller of a business in Maryland, Virginia, and DC has several legal options open to them. First, a seller can sell the entity in its entirety, instead of solely the assets. This full-entity sale will only result in a gain to the seller for the sale of the shares; therefore, only the seller — as an individual — is being taxed.
A second option requires advanced planning. This second option involves converting the “C Corporation” to an “S Corporation.” Therefore, the corporation would be taxed as a pass-through entity; eliminating the double taxation issue. However, this conversion election, when being completed for a sale requires advanced planning because of a look-back period that can cause the same tax issues as if the seller was selling a C Corporation. Prior to making this election for a sale, the seller should clarify the ramifications of the conversion with their attorney and accountant.
Finally, a third option is available for a seller to apportion a part of the sale proceeds to “personal goodwill.” This personal goodwill — if structured in the right way — allows a significant portion of the sale to be considered outside of the business being sold. Instead, a certain amount of goodwill (such as the individual’s own ability to attract customers) is deemed solely property of the seller. In this situation, the value of the individual’s goodwill in the purchase transaction would not be double taxed. This strategy was first described in the Maryland case of Berliner Foods Corp. v. Pillsbury Co. related to the sale of an distributor for Haagen-Dazs Ice Cream. In many cases in Maryland, Virginia, and DC, this goodwill strategy can help to eliminate double taxation on part of the transaction because this “goodwill asset” does not belong to the business but would belong to the seller. These three options are just three of the types of recommendations that can assist a seller in minimizing the taxes when selling a C Corporation in Maryland, Virginia, and DC. If the seller is selling an S Corporation or a sole proprietorship, then the asset sale is not as much of a concern for tax purposes compared to the sale of a C Corporation.
On the opposite side of the transaction, in Maryland, DC, and Virginia, it is generally advantageous for the buyer to purchase the assets instead of purchasing the stock or membership of a company. When purchasing the stock or membership interest of a corporation or company, a purchaser is not just buying the assets of the company, but also buying everything included in the history of the company or corporation. This “everything” purchase can include company debt and potential liability for lawsuits for the past actions of the company. Furthermore, additional debts that the purchaser can be liable are not just those debts that are currently on the company books. A buyer can remain liable for tax debts, tax audits, and lawsuits that occur years after the transaction is completed even if they were not the owner of the business during the year the incident occurred. While the purchaser can sometimes protect themselves from this liability with an indemnification from the seller, that indemnification will only be as good as the funds that the seller has to back it up.
In addition to the liability concerns that can arise when a purchaser buys the shares or membership interest of a company instead of solely the assets, the assets that the purchasers get in the business are also taken as the current book value for tax purposes. Therefore, the purchaser will not have the opportunity to depreciate those assets for the same value as if the purchaser had purchased the assets and given them a new basis for depreciation.
In conclusion, in Maryland, Virginia, and DC, there are advantages and disadvantages to each type of entity purchase arrangement. An argument can be made for (1) the benefits of purchasing the stock or membership interest of a business as well as (2) the benefits of purchasing the assets of the business. Each and every entity purchase deal is unique, and the specifics of each transaction should be thoroughly analyzed and reviewed to determine which purchase method is in the best interest for each side to proceed.
Longman & Van Grack’s business law attorneys regularly represent clients in many different business transactions and business purchases in Maryland, Virginia, and DC. Our attorneys are also familiar with all of the tax related concerns involved in these types of transactions. Robb Longman has assisted many clients through the process of buying and selling businesses and entities. If you would like to contact Robb or one of our other business attorneys, you can reach us at (301) 291-5027.