Tax Rules are changing and pest control business owners are benefiting! Facts: An S corporation that converted from a C corporation has a built in gain attributable to the period it was a C corp. If its assets are sold within a certain period after the S election it is subject to a corporate level tax – the Built in Gain Tax (BIG). Before 2009, the BIG applied to gains recognized during the first 10 years after the S election was effective. In 2009 and 2010, the effective recognition period for the BIG tax was shortened to seven years, and it was temporarily shortened to five years for 2011 – 2014. Until December 18, 2015 the BIG tax waiting period reverted back to 10 years. However, with the Tax Extenders passed December 18th the BIG waiting period was reduced permanently to five years.
The purpose for this law was to stop C corporations from selling all of their assets and liquidating the corporation and avoid paying their corporate level taxes by electing S Corp status. The tax is imposed at 35%, the highest corporate rate.
Tax Rules: How does this affect the PCO? When PCO firms sell, most deals are structured as an asset sale with the biggest asset being the value of the intangible called the customer list. At the moment a business elects S Corp status, the assets (including the customer list) must be assigned a value and if an asset sale occurs during the BIG tax waiting period the BIG tax kicks in based on the value at the S election date. This is bad news for any firms who are thinking of selling during the waiting period. While five years can be a long time, the prior ten year period was really tough.
Tax Rules: What PCO firms need to do if they have any inkling of selling: Currently S corporations are the most tax efficient entity structure for most PCO business owners. Most firms should be set up as an S corp. as the pass thru benefits make a single tax much more efficient than the potential double tax of a C corp. If the assets of a C corporation are sold they are subject to ordinary income tax rates anyway so by maintaining C corporation status in most instances does not make sense (unless you have NOLs – speak to your tax advisor to determine if converting makes sense). If it makes sense to be an S corp., you want to make the election ASAP and get the BIG tax clock started as it will take five years to eliminate the issue of the BIG tax which may be significant.
If you are thinking of selling your firm in the near future and the sale will take place within the BIG tax waiting period, it is highly advisable that you have a professional appraisal done of all assets owned by the firm including the customer list as of the date of the S election. This will provide evidence of the value when calculating the BIG tax should it ever be challenged by the IRS.
Daniel Gordon, owner of PCO Bookkeepers has teamed up with M&A Attorney John Corrigan and started the division PCO M&A Specialists. A team of experts who can help you to save the most money after taxes and guide you through the tax rules and regulations! To get in the loop and be made aware of tax rules and developments and other financial issues,when selling your pest control business, contact our Merger and Acquisition division, PCO M&A Specialists.