You built your S-Corp. It served you well. But now something changed. Maybe you're selling the business. Perhaps you're shutting down. Or you've grown to the point where C-Corp status makes more sense. Whatever the reason, you need an exit strategy.
Getting out of an S-Corp is more complicated than forming one. Tax consequences lurk around every corner. Miss a step and you could trigger unexpected tax bills. The IRS doesn't give do-overs on this stuff.
The most common reason is selling the business. S-Corp status complicates acquisitions. Most buyers prefer buying assets rather than stock. That creates a tax mismatch between what's best for the buyer and what's best for you.
Another reason is changing business needs. You're raising venture capital. Investors want preferred stock and complex equity structures. S-Corps can't offer that. You need to convert to a C-Corp.
You're ready to retire. You want to pass the business to your kids. Or maybe you're just done and ready to shut it down. Each scenario requires different tax planning.
The worst approach is ignoring the tax consequences until you're in the middle of a transaction. By then it's too late to optimize. You need to plan this stuff 12-24 months before you actually exit.
Working with a Denver business CPA who understands exit strategies protects you from costly mistakes. They model different scenarios. They show you the tax implications of each path. You make informed decisions instead of guessing.
The cleanest exit is revoking your S-Corp election and becoming a C-Corp. More than 50% of shareholders must consent. You file Form 1120-S for the final year as an S-Corp. Then you start filing Form 1120 as a C-Corp.
This makes sense if you're being acquired by a company that wants you as a C-Corp subsidiary. Or if you're raising institutional funding. Or if you've grown beyond the S-Corp restrictions on shareholder count and types.
Timing matters enormously. Revoke your election by March 15th and it's effective for the entire current year. Revoke it after March 15th and it's effective January 1st of the following year. You can also specify a future effective date.
This timing rule creates planning opportunities. Maybe you had a big income year and want to stay an S-Corp to avoid double taxation. You revoke effective January 1st of next year. You get one more year of pass-through treatment.
The IRS S-Corporation page provides instructions for voluntary revocation. Read it carefully. Missing a deadline or filing incorrectly can create a mess.
Sometimes you lose S-Corp status accidentally. You exceeded 100 shareholders. You issued a second class of stock. A shareholder sold shares to a trust that doesn't qualify. Boom. Your S-Corp election terminates immediately.
This is bad. Really bad. The termination creates a short tax year. You file two tax returns for the year: one as an S-Corp and one as a C-Corp. The paperwork alone is a nightmare. But the tax hit is worse.
If you were an S-Corp for less than five years when your election terminates, you face the built-in gains tax. Any appreciation in your assets while you were a C-Corp gets taxed at the corporate level when recognized as an S-Corp.
Let's say you bought a building for $500,000 as a C-Corp. Then you elected S-Corp status. The building is now worth $1,000,000. If you sell it within five years of your S-Corp election, you pay corporate tax on $500,000 of gain even though you're an S-Corp.
Add that to the pass-through taxation and you're facing double taxation on the same gain. This is why you need expert guidance from a tax accountant before making any moves.
Many Denver business owners convert their S-Corp to an LLC taxed as an S-Corp. You get the liability protection and operating flexibility of an LLC. You keep the tax benefits of S-Corp status.
Colorado makes this conversion relatively straightforward. You file Articles of Conversion with the Colorado Secretary of State. You update your operating agreement. You keep your EIN. Your S-Corp election remains in effect.
LLCs offer flexible profit allocations. S-Corps require pro-rata distributions based on stock ownership. LLCs let you allocate profits disproportionately if your operating agreement allows it.
LLCs also avoid corporate formalities like annual meetings and minutes. Your operating agreement governs everything. For many small business owners, this simplicity is worth the conversion cost.
The conversion isn't taxable if done correctly. But screw it up and you could trigger a taxable liquidation. This is absolutely a job for professionals. Don't attempt this DIY.
This is where exit planning gets complicated. Buyers want asset sales. You want a stock sale. The tax consequences differ dramatically.
In an asset sale, the buyer purchases your business assets individually: equipment, inventory, customer lists, goodwill. They get a stepped-up tax basis. They can depreciate these assets going forward. Good for them.
You get hammered on an asset sale. The corporation pays tax on gains at the corporate level. Then it liquidates and distributes proceeds to you. You pay capital gains tax on the distribution. Double taxation. The exact thing S-Corps are supposed to avoid.
Wait, you say. S-Corps are pass-through entities. They don't pay corporate tax. True for ordinary income. But asset sales trigger special rules. Goodwill and going concern value get ordinary income treatment. Recaptured depreciation gets taxed. It's a mess.
Your S-Corp tax strategy needs to address this years before you sell. Maybe you shift compensation structure. Perhaps you increase depreciation deductions. You definitely need to plan around the reasonable compensation rules.
Stock sales are cleaner from your perspective. The buyer purchases your S-Corp stock. You report the gain as long-term capital gain. Single layer of taxation. Current federal rate is 20% plus 3.8% net investment income tax. Done.
Buyers hate this. They don't get stepped-up basis in the assets. They inherit your tax basis. They can't depreciate assets. They might inherit unknown liabilities.
Smart deals find middle ground. Maybe the buyer pays more for an asset sale to compensate for your tax hit. Or you structure it as a stock sale with indemnification provisions protecting the buyer from unknown liabilities.
Earnouts and seller financing can bridge valuation gaps. The buyer pays part at closing and part over time based on performance. This spreads your tax liability across multiple years. It can actually reduce your total tax through proper structuring.
Professional guidance from someone doing fractional CFO work with tax strategy makes these negotiations work. They model the after-tax proceeds under different deal structures. They show you what you actually net, not just the headline purchase price.
Sometimes you're not selling. You're just shutting down. The business ran its course. You're moving on. You need to properly dissolve the corporation.
Start by filing your final Form 1120-S. Mark the "Final Return" box. Report all income and expenses through the date of dissolution. Distribute remaining assets to shareholders. Close your business bank accounts.
File Articles of Dissolution with the Colorado Secretary of State. Pay any outstanding taxes. Cancel your registered agent. Notify creditors. Settle outstanding debts. Close your sales tax account if you have one.
The Colorado Secretary of State dissolution page outlines the exact steps. Follow them precisely. Shortcuts create personal liability issues later.
Your bookkeeping services need to create a complete wind-down schedule. Track every asset disposition. Document all final payments. Generate final financial statements. This documentation protects you if questions arise later.
Your S-Corp has debt. Bank loans, equipment financing, credit lines. What happens to these obligations when you exit?
Stock sales mean debt stays with the corporation. The buyer assumes it. But lenders usually require the buyer to refinance in their own name. That creates complications if the buyer can't qualify.
You personally guaranteed the debt. Now you're trying to exit. The lender won't release your guarantee until the debt is paid or refinanced. This holds up deals. It adds stress. It limits your options.
Plan for this early. Start conversations with lenders 12 months before you plan to exit. Some lenders will release guarantees if the buyer qualifies and the business meets certain metrics. Others won't budge.
Part of your comprehensive tax planning includes exit planning. Reducing debt over time. Building equity value. Creating optionality. The businesses that plan for exits get better outcomes than those that wing it.
Here's a powerful tax benefit few Denver business owners know about: Section 1202 Qualified Small Business Stock (QSBS). If you meet the requirements, you can exclude up to $10 million of gain or 10 times your basis when you sell your S-Corp stock.
But there are catches. Your corporation must be a C-Corp when you acquire the stock and when you sell it. The corporation must have gross assets under $50 million. You must hold the stock for at least five years.
Some business owners voluntarily terminate their S-Corp election and convert to C-Corp status specifically to capture QSBS benefits. They run the math. Double taxation for a few years beats losing the QSBS exclusion on a $20 million exit.
This strategy requires sophisticated modeling. You need to project exit timing, valuation, and tax rates. A small change in assumptions can flip the optimal strategy.
The IRS provides guidance on QSBS in Revenue Ruling 2018-29. This is complex stuff. Don't attempt it without professional help.
Colorado's flat 4.4% income tax rate simplifies state planning compared to California or New York. But you still need to think about Colorado tax consequences of your exit strategy.
Colorado generally follows federal tax treatment of S-Corps. Asset sales get taxed at the corporate level. Stock sales get capital gains treatment. Liquidations distribute taxable income to shareholders.
If your business benefited from any Colorado tax credits, credits might recapture upon exit. Enterprise zone credits, historic preservation credits, film production credits—these all have recapture provisions if you don't maintain operations for specified periods.
Review any credits you claimed in the past five years. Calculate potential recapture. Factor that into your exit planning. Unpleasant surprises close to closing can kill deals.
Your exit doesn't end your tax obligations. You need to file final returns. Distribute Schedule K-1s to shareholders. Report asset dispositions. Close out accounts.
The final Form 1120-S is due two and a half months after dissolution. Extensions are available but you still need to pay estimated tax by the original deadline. Miss these deadlines and you face penalties and interest.
The IRS recommends keeping business records for seven years after you file your final return. Keep all contracts, asset records, debt documents, and corporate filings even longer. Future legal claims might require these documents.
Store digital copies in secure cloud storage. Keep physical originals of critical documents like Articles of Incorporation and Buy-Sell Agreements. You'll thank yourself later if issues arise.
Coordinate with your tax return preparation team on document retention. They can advise which records matter most and how long to keep them.
Mistake number one: waiting until you have a buyer to start planning. Exit planning should start years before you actually exit. Restructuring after you're in a deal creates time pressure and reduces negotiating power.
Mistake number two: ignoring the reasonable compensation rules. The IRS looks hard at S-Corp exits. If you've been taking minimal salary and large distributions, they might challenge your compensation structure and assess payroll taxes retroactively.
Your business is worth what a willing buyer will pay. But for tax purposes, you need defensible valuations. Lowball valuations to avoid gift tax on transfers to kids won't hold up. Neither will inflated valuations to justify stock-based compensation.
Hire a qualified appraiser before any ownership transfers. The cost is tax-deductible. The protection is priceless.
Even if you're not planning to exit anytime soon, start thinking about it now. The businesses that plan exits get better outcomes. They build value systematically. They structure things correctly from the start.
Schedule a planning meeting with your tax advisor. Talk through different exit scenarios. Understand the tax implications of each path. Make strategic adjustments now that improve your position later.
Partner with professionals who understand business tax strategy and exit planning. They've seen hundreds of exits. They know which structures work. They can protect you from expensive mistakes.
Your S-Corp served you well. Make sure your exit does too.
