We are often asked this question before undertaking an engagement. Here are some alternatives:
1. Set up a Charitable Remainder Trust (“CRT”). Either stock or assets can be contributed to a CRT and then sold by the CRT, a tax-exempt entity. The charitable contribution of assets or stock generates an income tax deduction for the owner equal to the present value of the charitable gift. The present value is based upon the life expectancy of the owner (and perhaps the owner’s spouse, both of whom could be beneficiaries of the CRT), the amount of income to be paid to the beneficiaries annually, and the federal discount rate at the time of the transfer. The trustee of the CRT then sells the stock free of any long-term capital gains taxes. The funds in the CRT grow tax-free, and provide an annual income for the beneficiaries. The owner-beneficiary can act as trustee of the CRT and direct the investment strategy. At the death of the beneficiaries, the assets in the CRT pass estate tax-free to the designated charity, which could be a private foundation established by the owner. The children of the owner can serve as trustee of the private foundation, and may even draw an annual salary.
2. Adopt an Employee Stock Ownership Plan (“ESOP”). The owner of a C corporation can sell his or her stock to an ESOP without tax, provided the owner reinvests the proceeds of sale in replacement securities of domestic corporations within one year after the sale, and the ESOP owns not less than 30% of the Company’s stock after the sale. Any replacement securities sold during the owner’s lifetime will generate a tax on the difference between the sales proceeds of the replacement securities and the pro rata basis of the stock of the C corporation. Any replacement securities not sold will receive a step-up in basis at the owner’s death, and, thus, the sale of the C corporation stock will have been (income) tax-free.
3. Exchange the business in a Section 1031 exchange. This is a strategy to be used where the owner wants to continue in business, rather than exit. It operates like a tax-free exchange of real estate, which is the customary reference to Section 1031. The owner of the business transfers business assets to an escrow agent, which then sells the assets; so long as replacement business assets are purchased within six months of the sale, the sale is tax-free. The tax could even be deferred indefinitely.
4. Set up an off-shore entity to accomplish the transaction. There are multiple mechanisms that allow for the tax-free exchange of stock with an off-shore entity located in a tax-free jurisdiction that than sells the stock of the domestic company. The proceeds remain tax-free so long as they are invested and/or enjoyed off-shore. Once repatriated the proceeds are taxable. There are opportunities to have the gain taxed in a low-tax jurisdiction, such as Ireland, where the income tax is 7%, and then repatriated without further tax. These aggressive tax strategies may be perfectly legal, but they are not for the faint of heart.
We regularly assist owners of closely-held corporations with the sale of their assets or stock, and structure transactions to avoid or minimize income taxes. If you have any questions about the sale of your company or the methods to reduce the tax consequences thereof, please do not hesitate to contact us.