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  1. Home
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  3. Pre-transaction Tax Structuring Considerations for the Closely-held Business

Pre-transaction Tax Structuring Considerations for the Closely-held Business

Posted by Margaret Amsden and Benjamin Smith on December 13, 2020

Margaret Amsden

Business owners and entrepreneurs typically operate in a very fast paced environment and, as a result, can be unprepared for a transaction when the opportunity arises. If they face a potential transaction to raise capital, sell their business or acquire another company, they may not have had time to consider options to restructure their existing company in order to simplify or streamline the transaction. A few options should be considered.

Consider a Reorganization
Many companies operate as S Corporations. While this structure provides noted benefits, there are also limitations related to who can be an owner of an S Corporation. For example, S Corporations limit owners to US individuals and certain trusts; thus a C Corporation, partnership, or foreign individual cannot be an owner. If a business owner is considering selling a portion of his ownership in a company as part of a succession plan, or is considering admitting new owners to raise growth capital, an S Corporation structure can be a challenge.

A common work around is to enter into an F Reorganization under Internal Revenue Code (IRC) Section 368. With this structure, the operating company becomes a subsidiary of the S Corporation and allows the owners to continue owning their portion of the operating entity through an S Corporation, while allowing new investors to invest directly into the subsidiary.

Other benefits of a reorganization include the ability to sell all or a portion of a company more easily if it has:

  • non-transferable contracts
  • vendor numbers tied to the existing entity
  • a large quantity of contracts

If the current entity is operating as a partnership, it may also be beneficial to create a Limited Liability Company (LLC) to function as a holding company to realize similar benefits.

Consider Management Equity Plans
As a company is growing, key employees will be brought on board to take on management roles, help grow the company, and add to the value. It is critical for a business to retain key individuals, especially when it is time to sell or enter into a transaction to obtain growth capital. One retention option is to implement a management equity plan. These plans vary widely and can include phantom ownership, actual ownership, and ownership that vests over time or based on performance. Key to each option is the benefit to key employees who have helped to grow and expand the business.

Consider Family Wealth Transfers
Often, the best time to gift a portion of a company to children or other family members is when the value is low. Entrepreneurs are often hesitant to give up control or make a transfer to family members until they are sure that the company is going to thrive. Thus it is important to monitor overall company value and consider timing gifts to occur prior to a transaction. When an owner decides to make a gift, the company must be valued, and the value may be set at a higher number if it is established by reference to a letter of intent, or a consummated transaction; hence making transfers prior to transactions beneficial.

Contact Us

If your company is growing, or you see a potential transaction in your future, Clayton & McKervey can review how these strategies may help you. For additional information, call us at 248.208.8860 or click here to contact us. We look forward to speaking with you soon.

Our team is always ready to help.

Please contact us for more information.

Margaret Amsden

Shareholder, Private Client Services

Contact Margaret   |   Read Margaret's bio

Benjamin Smith

Senior Manager, Consulting

Contact Ben   |   Read Ben's bio

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Pre-transaction Tax Structuring Considerations for the Closely-held Business

Posted by Margaret Amsden and Benjamin Smith on December 13, 2020

Margaret Amsden

Business owners and entrepreneurs typically operate in a very fast paced environment and, as a result, can be unprepared for a transaction when the opportunity arises. If they face a potential transaction to raise capital, sell their business or acquire another company, they may not have had time to consider options to restructure their existing company in order to simplify or streamline the transaction. A few options should be considered.

Consider a Reorganization
Many companies operate as S Corporations. While this structure provides noted benefits, there are also limitations related to who can be an owner of an S Corporation. For example, S Corporations limit owners to US individuals and certain trusts; thus a C Corporation, partnership, or foreign individual cannot be an owner. If a business owner is considering selling a portion of his ownership in a company as part of a succession plan, or is considering admitting new owners to raise growth capital, an S Corporation structure can be a challenge.

A common work around is to enter into an F Reorganization under Internal Revenue Code (IRC) Section 368. With this structure, the operating company becomes a subsidiary of the S Corporation and allows the owners to continue owning their portion of the operating entity through an S Corporation, while allowing new investors to invest directly into the subsidiary.

Other benefits of a reorganization include the ability to sell all or a portion of a company more easily if it has:

  • non-transferable contracts
  • vendor numbers tied to the existing entity
  • a large quantity of contracts

If the current entity is operating as a partnership, it may also be beneficial to create a Limited Liability Company (LLC) to function as a holding company to realize similar benefits.

Consider Management Equity Plans
As a company is growing, key employees will be brought on board to take on management roles, help grow the company, and add to the value. It is critical for a business to retain key individuals, especially when it is time to sell or enter into a transaction to obtain growth capital. One retention option is to implement a management equity plan. These plans vary widely and can include phantom ownership, actual ownership, and ownership that vests over time or based on performance. Key to each option is the benefit to key employees who have helped to grow and expand the business.

Consider Family Wealth Transfers
Often, the best time to gift a portion of a company to children or other family members is when the value is low. Entrepreneurs are often hesitant to give up control or make a transfer to family members until they are sure that the company is going to thrive. Thus it is important to monitor overall company value and consider timing gifts to occur prior to a transaction. When an owner decides to make a gift, the company must be valued, and the value may be set at a higher number if it is established by reference to a letter of intent, or a consummated transaction; hence making transfers prior to transactions beneficial.

Contact Us

If your company is growing, or you see a potential transaction in your future, Clayton & McKervey can review how these strategies may help you. For additional information, call us at 248.208.8860 or click here to contact us. We look forward to speaking with you soon.

Our team is always ready to help.

Please contact us for more information.

Margaret Amsden

Shareholder, Private Client Services

Contact Margaret   |   Read Margaret's bio

Benjamin Smith

Senior Manager, Consulting

Contact Ben   |   Read Ben's bio

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The persistence of the COVID-19 pandemic has created challenging business conditions in Michigan and across the U.S. The second wave of infections has forced many state and local government agencies…

Read full story

PPP Loan Round 2 – Should You Apply?

A new round of PPP loans (PPP2) was ushered in with the passage of the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (Economic Aid Act) on December…

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Understanding Transactions, Even if Your Business Isn’t for Sale

Selling your small business may not have been your focus in 2020 and may not be your focus in 2021. With an economy in flux and public health at the…

Read full story

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In a world that is becoming more global, many companies have focused their resources on dealing with new international markets. While important, it is also imperative businesses do not take…

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  • Tarah Ablett
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  • Tim Hilligoss
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