Selling Shares in a Private Company Tax Implications

As with any securities transaction, it is advisable to consult with the company`s legal and tax advisors to ensure that all necessary approvals have been obtained, determine the appropriate tax, reporting and source requirements and prepare the correct documentation. Other important legal considerations need to be taken into account, including disclosures that the seller makes to the buyer and who knows what at that time. Will the issuer information be passed on to competitors or will it cause harm if it is learned by customers? These concerns can be highlighted in a takeover bid by a company or a third party to the owners. What will be said about the transaction in a future S-1 application? How will the transaction affect a Corporation`s previous or subsequent determination of the fair value of its common shares to grant future share allocations (para. B the “409A value”)? What capital gains are reported? How will such a transaction affect the tax-free federal status of shares under Section 1202 of the Internal Revenue Code, commonly referred to as the “QSBS Rules”? As with any transaction with shares, the parties may be held liable to the other parties for the disclosure of relevant material and non-public information (or failure to provide the information!). This is crucial if sellers don`t have board-level details about the company. Whether the company presents a liability risk depends on its involvement and the relevance of the undisclosed information. Disclosures to potential buyers can lead to leaks to competitors, customers, suppliers or other players in the ecosystem that could be dangerous to the issuer of the share. Many private companies only sell shares to family members. The purchase of shares priced in excess of what the Board of Directors of the Corporation otherwise considers to be the “fair market value” of the common shares carries the risk that current or former employees or service providers who sell shares will not be able to claim the treatment of capital gains for 100% of the sale price. Therefore, the difference may have to be taxed as regular income, and then the company may have a withholding obligation. Liquidity operations can be structured as a share buyback by the company – financed by cash on the balance sheet or by cash from equity financing. Alternatively, the transaction can be structured as a direct purchase of shares by a third party that combines the purchase with the primary equity financing of a company or even as a stand-alone transaction.

In a company-sponsored transaction, the company must decide on the limits and shareholders who can sell shares. How do you ensure that your company has control over secondary stock transactions in the future? It would be helpful if you considered introducing a “right of first refusal” on transfers of shares in your company. Ordinary shares may be subject to a right of first refusal, which gives the possibility of buying shares that a shareholder wishes to sell to third parties. The right of first refusal is usually included in the articles of association of the company, so it automatically applies to all shares issued after the adoption of the articles of association. This is a useful way to control ownership of the shares to the extent that the company or its assignee can spend the necessary funds to purchase the shares. If this is not the case, the shares can be sold to the proposed buyer. In addition, transactions that occur between the Company, its officers and other persons during the three years preceding the IPO must be disclosed as related party transactions in the filing of the Company`s IPO on Form S-1. A purchase by a third party in which the Company is not involved may be required, depending on the materiality of the disclosure.

Some states, including Delaware and California, have legal balance sheet tests that limit the amount of capital a company can use to buy its shares. In the past, a shareholder of a private company had to wait until the company went public or was acquired in order to obtain a return on welding capital or initial capital. But as the path from brainstorming to listing has been extended over the course of this century, the pressure to maintain or facilitate a liquidity transaction has also been extended. Selling private shares is more difficult than selling shares on a public market. Unlike a public market, there are few transactions, so previous selling prices are very unreliable. Typically, the seller and buyer consult with accountants who have experience in determining the value of tightly held companies to arrive at their own estimates of the value of shares. Both parties negotiate a price. The price that the seller receives must be indicated when calculating capital gains independently of other valuations. After the sale of assets by C Corporation, the company pays corporate tax at the standard rate. In order for shareholders to receive the after-tax proceeds from the sale of assets, C Corporation must then distribute a dividend to them. This dividend is taxable to the shareholder at the rate of capital gains tax.

The payment by the company of taxes on the sale of assets and the subsequent payment of taxes on the dividend to shareholders are called double taxation. .

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