BLOG: Introduction to taxation of sale proceeds: S corporation

January 30, 2023

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Our next post in this series addresses the taxation of sale proceeds if a target practice is classified as an S corporation.

Below we provide a high-level summary of the US federal income tax treatment of a sale of assets by an S corporation versus a sale of stock of an S corporation. State and local tax consequences must also be considered, adding nuances that must be fully considered on a case-by-case basis. The tax consequences of selling a medical practice are complex, and it is important to consult with your tax advisor early in the sale process.

Our next post in this series addresses the taxation of sale proceeds if a target practice is classified as an S corporation.
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Stock Sales: As with a C corporation, each shareholder will generally recognize gain or loss equal to the difference between the portion of the purchase price received and the tax basis in such shareholder’s stock. Such gain or loss will generally be long-term capital gain or loss to the extent that the selling shareholder has held the stock for more than 1 year. Long-term capital gains currently recognized by an individual are subject to US federal income tax at a maximum rate of 20%, and short-term capital gains are currently taxed at a maximum rate of 37%.

William Needle

Asset Sale: The S corporation will generally recognize gain or loss with respect to each asset equal to the difference between the amount of the purchase price allocated to such asset and the tax basis of such asset. Such gain or loss will be capital or ordinary depending on the type of asset. However, unlike a C corporation, an S corporation is generally not subject to US federal corporate income tax on such profits, subject to certain exceptions (e.g., if the practice is a former C corporation operating within the converted in the last 5 years). Instead, each shareholder is subject to tax on his or her pro rata share of any profit recognized by the S corporation. A significant portion of the purchase price tends to be allocated to goodwill or other capital assets, and thus a significant portion of the profit allocated to the shareholders tends to be capital gain. Furthermore, sale proceeds can generally be distributed to the shareholders without additional US federal income tax.

Reuven Graber

Unlike with a sale of C corporation stock, the 3.8% net investment income tax generally does not apply to gain recognized on a sale of S corporation stock or gain attributable to a shareholder from a sale of the assets of the S corporation to the extent that the relevant shareholder “materially participates” in the business of the S corporation.

Laurie Abramowitz

Observations: It is common for an entity that owns a medical practice to be classified as an S corporation, although practices may be classified as C corporations or partnerships. Unlike an asset sale through a C corporation, an asset sale through an S corporation generally does not result in two levels of US federal income tax and is therefore generally an acceptable structure for both buyers and sellers . Note that it is possible to achieve the US federal income tax results of an asset sale without actually selling the assets of the S corporation if the parties to the transaction make certain tax elections or engage in certain pre-closing restructuring transactions.

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