Don’t let friends start ‘C’ Corporations

In early 2002, I addressed the penalizing tax disadvantages to propane companies that are structured as ‘C’ Corporations.

Carl Hughes

Four years later, I remain shocked at the number of propane companies who continue to retain their ‘C’ Corporation structure when clearly superior options are available.

Simply stated, there are no ongoing benefits to a retail propane company to remain structured as a ‘C’ Corporation when weighed against the tax penalties that would result if the company is sold.

To best make this point, let’s compare two commonly used legal structures, the ‘C’ Corporation and the Sub Chapter ‘S’ Corporation.

A primary tax distinction is that the C Corporation is required to pay federal income taxes on net income while the income tax treatment for an S Corporation is treated at the shareholder level. Further, on the sale of the assets and liquidation of a company, the tax rules are very different.

We will lay side-by-side two companies identical in all relevant characteristics except for the type of legal structure under which they operate. In this example, I will simplify considerable accounting and tax code information to better explain the gist of the argument.

To keep the comparisons as simple as possible, we’ll consider only federal income tax consequences (ignoring state and local taxes) and make broad but safe assumptions on the tax calculations. These examples are based on a transaction type where assets are exchanged for cash.

In this very realistic example, the sale of the company under the Sub Chapter S Corporation structure netted the sellers almost $1.5 million more than the ‘C’ Corporation’s structure.

Assumptions on sale of propane

Often the tax penalty on the sale of the ‘C’ Corporation structure is referred to as the double tax issue. As the example shows, this is because – unlike the ‘S’ Corporation – the ‘C’ requires a second liquidation step in order to get the sale proceeds into the shareholder hands.

Even if your company is not for sale today, an unexpected death or other occurrence may force your shareholders or heirs to consider a future sale. It’s also important to note that if your objective is to create value for future generations, minimizing the tax consequences of a potential sale should be one of your top considerations.

Many companies have elected to convert from a ‘C’ Corporation to an ‘S’ Corporation. The process requires 10 years for the full tax advantage to take effect. However, you begin to get immediate benefit from the structure in that once converted, all subsequently acquired assets are treated in the single taxation format.

I strongly recommend consulting with a tax professional who is experienced in these matters.

Carl Hughes is vice president of business development for Inergy LP. He can be reached at
Chughes@InergyServices.com
or at 816-842-8181.