How to Exit an S Corp

By Mark Kennan

Whether you've made your money from owning an S corp or decided that you've lost too much to continue, you can end your ownership by selling off all your stock in the S corporation. However, unlike shares in a publicly traded C corporation, you might have to jump through a number of hoops to sell your stock and exit an S corp.

Finding a Buyer

Depending on the terms of ownership in the S corp, you might be limited in your options as to who can buy your shares. S corps cannot have more than 100 owners and generally owners must be either U.S. citizens or U.S. residents, otherwise the S corp loses its special tax status. Therefore, S corps often impose transfer restrictions on the shareholders that restrict sales. The restrictions may be found in the S-corp's bylaws or in a separate shareholder agreement. These restrictions may require that you first offer your stock to the existing shareholders, allow the S corp to buy back its stock or require the existing shareholders to approve the new buyer.

Setting a Price

Some S-corp agreements contain clauses that set the price of the sale of any S-corp stock. For example, a clause might set a specific dollar amount that the S corp has to pay to redeem the shares. Alternatively, the clause could set the valuation at book value or require that a valuation expert be used to judge the fair market value of the stock. If there isn't a clause specifying price, you can sell for whatever price the buyer is willing to pay.

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Completing the Sale

When completing the sale agreement, make sure that you include any required terms as mandated by the S-corp rules. For example, the buyer may be required to sign any existing shareholder agreements. In addition, you can structure the sale to make certain payments contingent on the company's performance. For example, you might agree that the buyer will pay $200,000 upfront and an additional $40,000 each year for the next three years, but the annual payments are contingent on the S corp meeting certain sales goals.

Final Tax Implications

When you sell your interest in an S corp, your capital account is closed out. However, since an S corp is a pass-through entity, you're still responsible for reporting the income earned during that part of the year during which you were an owner on your taxes. For example, if you sell your interest on February 28th, you need to report the income and expenses from January and February on your personal tax return. To help you, the S corp should issue you a final Schedule K-1 that breaks down the income and expenses you need to report.

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How to Change Ownership in an S Corporation
 

References

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