If the target in a business acquisition is an S Corporation, or S Corp, and the purchaser wants to retain that tax status, part of the purchaser’s due diligence should revolve around whether the seller properly obtained and maintained its S Corp election. An S Corp is a flow through entity that is generally not subject to income tax. Instead, the owners of an S Corp are allocated and pay tax on the taxable income of the entity. Purchasers should ask the seller for copies of the original election for S Corp status and the Internal Revenue Service approval. The Internal Revenue Code contains restrictions on who can be an owner of, and the kind of shares of stock that can be issued by, an S Corp. So, the purchase agreement should contain statements by the seller that all of those specific restrictions have been abided by. If the purchase is a two-step process, that is, first the signing of a purchase agreement and later a closing, the purchase agreement should contain promises by the seller to not take any action that would revoke the S Corp status. Last, if the purchaser is an S Corp and is obtaining seller financing as part of the purchase price, care must be taken to assure that the financing will not be reclassified as stock. An S Corp is allowed to have only one class of stock, except if the only difference between the classes are voting rights.
ABOUT GLENN D. SOLOMON
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Glenn D. Solomon is a principal at Offit Kurman and has provided counsel to businesses and business owners for more than twenty-five years. He has extensive experience in the purchase and sale of businesses, structuring ownership agreements, and advising companies in financial distress.
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