Considering Disposition of Ownership Interest When Choosing a Business Type

Disposition of Ownership Interest

Sole Proprietorship

The sole proprietor who sells the business is treated as selling the individual assets of the business. The income tax treatment of the sale will depend on whether or not the property is a capital asset, and the length of time the property has been held. The assets may also be subject to state sales tax. A sole proprietor also may change the form of the business without selling its assets, such as by joining with one or more persons to form a partnership or a corporation, and then transferring the assets of the sole proprietorship to the new organization. The tax consequences of such a transfer should be discussed in advance with a competent tax advisor.

Partnership

The sale or exchange of a partner’s interest in a partnership ordinarily results in capital gain or loss on the difference between the amount realized and the adjusted basis of the partner’s interest in the partnership. Special rules apply to exchanges of an interest in one partnership for an interest in another, liquidation of a partner’s interest, and the treatment of unrealized receivables and inventory items. Tangible assets sold as part of the transaction also may be subject to state sales tax. Because of the complexity of the tax laws affecting the disposition of a partnership interest, the tax consequences of such a disposition should be thoroughly explored in advance with a competent tax advisor. Note also that under the Revised Uniform Partnership Act (RUPA), Minnesota Statutes Chapter 323A, (RUPA) mergers of partnerships are allowed. Again, because of the complexity of tax laws, a competent tax advisor should be consulted when considering a merger of partnerships.

Corporation

Disposition of an ownership interest (shares of stock) in a corporation must be distinguished from liquidation of the corporation. Individual shareholders who sell their stock generally will recognize capital gain or capital loss on the sale of their shares. The gain or loss will be long term or short term, depending on the length of time the shares were held. An interest in a corporation also may be disposed of by complete or partial liquidation of the corporation. In liquidation, the corporation may either dispose of its property for cash, and distribute the cash to its shareholders, or it may distribute its property to the shareholders in exchange for the corporation’s capital stock held by those shareholders. In either case, the distribution generally will result in capital gain or capital loss to the shareholders. Tangible assets sold as part of the transaction also may be subject to state sales tax. In some cases, the timing of the transaction may affect the tax consequences. The tax consequences of corporate liquidations and stock redemptions for both C corporations and S corporations and their shareholders can be complex. For this reason, it is advisable to consult with a competent tax advisor prior to attempting to liquidate the corporation or dispose of corporate assets.


CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.

This is also part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.
Previous post: