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You are here: Experts > Business > Corporate Law > Tax Law (Questions About Taxes) > buy out of partner in an S Corp
Expert: Ivan Roth
Date: 5/11/2008
Subject: buy out of partner in an S Corp
Question
QUESTION: Hi,
I am co-owner in an S Corp with another individual. We each own 50%. We pay ourselves salary and have profit sharing each year. At the end of the year we take the S Corp balance down to zero to not show a profit from a company standpoint. Therefore, we are only personally each liable for our taxes.
We have agreed to a buyout price. Now we are discussing the payout terms from a tax standpoint.
He wants to do profit sharing and salary until we have reached the final payout. I don't really want to do that because it will take a fairly long time since we have to take out equal amounts in profit sharing, and I need to leave enough money in the company for general operations. Also, I would be paying his self employment taxes on his salary during the payout period.
So, I am proposing that he just invoice the current company from his new company for the new couple of months until we have reached the final payout amount.
Is this a good, fair way to do it from a tax standpoint?
thanks in advance!!!
ANSWER: Hi First make sure that you do not purchase the whole 50% in a twelve month period as a change of 50% or more in one year terminates the c corp. (49.9 is ok)
Remember the earnings are distributed in an ownership basis so the billing idea is not proper.
However if the other person does no longer perform services but receives a portion of the profits because of ownership the profit would not be not subject to the self employment tax.
---------- FOLLOW-UP ----------
QUESTION: Thanks. I will definitely not purchase the entire 50%.
Can I use company money to fund the buyout and take that as a company expense? Or do I have to use personal after tax money to fund the buyout?
We are a consulting company, so he would still be working under my company until the final payment is made. Basically, I am trying to avoid him being on the payroll and the company (me) paying for his self employment while I am slowly paying him out.
What is the best way (from a tax standpoint) to buy my partner out with payout over a 3-4 month period?
thanks!!
Answer
HI The S corp can purchase the stock as Treasury Stock out of the corporate funds but there is no deductible expense associated with it
Lately the IRS has issued an IRb warning tax professionals of the need to allocate reasonable salary expenses to stockholders of an S corp in order to avoid reduction the Self employment tax ( as you are thinking)
Including compensation in the purchase price is no help to you
so it seems to me that the sooner you can close the deal the better!!
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