With the increase in the tax rate, should owners shy away from choosing an LLC as an entity type?
For the last 15 years, the best advice has been to set up a new business as an LLC, and that is still good advice. Yes, you are looking at potentially higher tax rates, but if higher rates turn out to be problematic, the business could likely convert to a corporation and take advantage of lower corporate tax rates.
Now may actually be a good time to convert an existing corporation to an LLC, even though it is a fully taxable transaction. The tax rates are currently lower than we will likely ever see in the future, and the economy is still struggling. If your corporation was worth $10 million five years ago, you may now be able to take a position that it is worth significantly less today. Sales are down, profits are down and the future is uncertain.
The tax on the conversion is based on the value of the business, and if you can justify a really low value, and are taxed at a historically low tax rate, now may be the time to convert to an LLC. Many corporations have also sustained net operating losses for the past couple of years, which can be used to offset a portion of the gain on the conversion.
What does a business owner need to think about regarding entity type before selling a company?
Business owners often get hit with huge tax bills for having the wrong type of entity when they sell the business. Before deciding to sell, a business owner needs to think about the tax consequences as early as possible in the process. If the business is a C corporation and is sold in a transaction structured as an asset sale, the aggregate tax rate between the C corporation and the shareholder could be more than 50 percent of the sales price. There are some planning techniques that can be used, but these require advance planning, so the earlier the better.
Whether you are thinking about selling soon or far into the future, now is a great time to be thinking about this. People tend to wait until they are ready to sell, and then say, ‘Why didn’t I do something about this before?’ You really must look at the facts and circumstances, forecast what is likely to happen with the business in the midterm horizon and then make your decisions based on that.
Mark Klimek is chair of the Tax Practice Group at McDonald Hopkins LLC. Reach him at [email protected] or (216) 348-5453.
