Typically, you will transfer your interest in the business to others or to your corporation in return for cash or property. This will generally result in capital gain (or loss) (or in some cases, dividends) or ordinary gain (or loss).
Caution: When considering any sale of an interest in a business, be sure to examine all relevant documents or laws for restrictions or conditions placed on the sale of your interest in the business. These might include the document creating the business, a stock certificate, a buy-sell agreement, a loan agreement, or state or federal laws. Restrictions or conditions might be placed on (1) who you can sell your interest to; (2) whether, when, or under what conditions you can sell your interest; or (3) the price that you can sell your interest for.
What Is an S Corporation?
An S corporation is a small business entity that is treated as a regular corporation for all purposes other than its treatment under tax law. To make a "subchapter S election," a corporation must satisfy a number of requirements:
- All shareholders must consent to the S corporation status
- The number of shareholders is limited to 100
- The corporation can issue only one class of stock
- The S corporation must be a domestic corporation, and its shareholders must be citizens or residents of the United States
- Only individuals, estates, S corporations, and certain trusts can be shareholders of the S corporation
In effect, an S corporation conducts business as a regular corporation but is taxed similarly to a partnership. Unlike a C corporation, the S corporation generally does not pay a corporate tax on income. Rather, the S corporation passes income, losses, deductions, and credits through to its shareholders, who report the items and calculate the tax on their individual returns.
How Is The Sale of Stock In an S Corporation Taxed?
In general, the sale of stock in an S corporation is treated the same as the treatment of the sale of stock in a C corporation. Generally, the sale of your stock in a corporation results in a capital gain or loss. Thus, a sale to another person or an entity other than the corporation typically results in a capital gain or loss. However, a redemption of your stock by the corporation may be treated as a sale or exchange of the stock or as a dividend.
How Is A Redemption of Stock In an S Corporation Taxed?
A redemption of your stock by the corporation can be treated as a sale or exchange resulting in capital gain or loss under certain circumstances. In general, a redemption of stock is treated as an exchange if the redemption is not essentially equivalent to a 1dividend, the redemption is substantially disproportionate and meets certain requirements, or the redemption terminates your interest in the corporation (attribution rules may apply).
Under the general rule for corporations, a distribution with regard to a redemption that is not treated as an exchange of your stock is taxed first as a dividend to the extent of earnings and profits (if any), then received tax free to the extent of your basis in the stock, and the balance is treated as capital gain.
Tip: An S corporation generally does not have earnings and profits unless the S corporation was a C corporation for one or more years after 1982 or the S corporation has earning and profits from before 1982. If an S corporation does not have earnings and profits, the distribution is essentially treated the same as an exchange (first recovery of basis, and then capital gain).
Since S corporations are generally pass through tax entities and shareholders are taxed currently on their distributive share, S corporations keep track of an accumulated adjustments account. This is essentially an account of the S corporation's post-1982 receipts reduced by deductible expenses, to the extent not previously distributed. In general, distributions are treated as made from this account before they are treated as distributions of earnings and profits.
If the S corporation has earnings and profits, a distribution with regard to a redemption that is not treated as an exchange of your stock is first treated as an exchange (first recovery of basis, and then capital gain) to the extent of the accumulated adjustments account. The balance of the distribution is treated first as a dividend to the extent of earnings and profits, then received tax free to the extent of your remaining basis in the stock, and the balance is treated as capital gain.
Note: Long-term capital gains and qualified dividends are generally taxed at 0%, 15%, or 20%, depending on the amount of the taxpayer's taxable income. An additional 3.8% Medicare tax applies to some or all of the investment income for married filers whose modified adjusted gross income exceeds $250,000 and single filers whose modified adjusted gross income is above $200,000.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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