Avoid Double Taxation When You Sell Your Company

by Joe Ciccarello, CPA, MST, Managing Partner, Gray, Gray & Gray, LLP

The successful rebound of the retail energy sector over the past two years has led to a surge in merger and acquisition activity. Many dealers are looking to exit the business while their companies can command top dollar, and others are just as eager to acquire suddenly profitable businesses.

Our recent industry survey found that 17 percent of oil company owners are considering selling their business, while 35 percent are looking to acquire another company. (Another 22 percent are hoping to keep their business in the family by making a transition to the next generation, which opens up another set of challenges related to financial and tax issues.)

It may be a “seller’s market” right now, but, like the winter-weary streets across the Northeast, there are potholes on the road to riches.

Our firm recently completed a valuation for the owner of a retail oilheat company who is contemplating selling his business. Happily, our valuation was right in line with the owner’s expectation. The selling price in today’s market would bring a significant windfall. But we had to break some bad news to the owner: He is unlikely to pocket nearly as much money as he hoped. Here’s why.

Because the company is structured as a C Corporation, the owner will almost certainly be hit with a “double tax” if the Corporation sells the assets of the business. Legally and for income tax purposes, C Corporations and the owners are treated as separate entities, with their own tax obligations. The company will initially be taxed on the sale of the assets. Then the owner will be taxed again on the proceeds he receives when the corporation distributes the cash to the owners. Depending on the final sale price and several other factors, the net proceeds after taxes could be cut in half.

(All this assumes the most likely scenario for the sale: that the buyer wants to buy the assets of the business, and not purchase the stock, which can come with multiple liabilities.)

As a result of this grim scenario, the owner is reconsidering his plans to sell the business. And, in case you think this was an isolated situation, this was the second oil company owner in as many weeks that came to us facing the same problem.

Planning Ahead

How could this unfortunate situation be avoided? If, five or 10 years ago, the oil company owner had looked ahead and anticipated the possibility of selling his company in the future, I would have advised him to convert to an S Corporation. An S Corporation is generally not a taxable entity; the income is taxed directly to the shareholders and in most instances avoids the double tax. Sidestepping the hit from the double tax can mean significantly more money in the owner’s pocket.

Is it too late to convert from a C Corporation to an S Corporation? No but it will not help by having a last-minute conversion. The government has imposed a waiting period before the double tax is completely eliminated. The waiting period can be anywhere from 5 to 10 years.

Does that mean that a sale transaction will not happen if your business is still operating in a C corporation? It can be done. But it takes some “outside the box” creative tax planning by someone who has a full understanding of the tax laws and knows the ins and outs of an energy business.

For example, let’s look at the two oilheat company owners who recently approached us about selling their C Corporation businesses. One is still mulling over his options. But we were able to help the other owner minimize the amount he will have to pay in taxes by addressing the way the purchase price will be allocated to the various assets to be sold, along with other actions. At the time I am writing this he is still planning to sell the business and move on with his future plans.

Lessons Learned

What lessons can we take from this? First, take a long-term view of your business. It is easy to get caught up in day-to-day operations and lose sight of the direction in which your business is traveling. You should be working with an advisor to develop a plan that looks five to 10 years ahead, with the flexibility to accommodate potential changes in the market and the company.

If there is even the slightest possibility of selling the company at some point down the road, you should be an S Corporation now. If your business entity is currently a C Corporation, consult with an expert to see what it would take to elect a change in status, and to calculate the possible tax savings you’d enjoy in five to 10 years. The investment in becoming an S Corporation today could pay immense dividends for you when you do sell the company.

Oilheat and propane businesses can be complex and subject to a wide range of unique market pressures and challenges. Having a good understanding of how the industry has evolved – and how it continues to change – can mean the difference between a successful sale and one that is disappointing, if not disastrous.

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