Thinking About Selling or Shutting Down Your S Corporation? Here’s what to know about taxes

If you’re getting ready to sell or close your S Corp, you’re probably wondering what it’s going to mean for your taxes. The short answer: it depends on how you structure the exit. Let’s walk through two common scenarios and explore what each means for selling your S Corp.

Selling Your S Corp

If You Sell the Stock

One straightforward option is to sell your shares of the S corporation stock. If you go this route, the money you make — your profit — is usually treated as a capital gain for tax purposes. Even better, if you’ve owned the stock for more than a year, it’s considered a long-term capital gain, which gets you a lower tax rate.

Right now, the maximum federal tax rate for long-term capital gains is 20%. But that top rate only kicks in if you’re making a pretty high income — over $518,900 if you’re single or over $583,750 if you’re married and filing jointly. If you’re under those numbers, your tax rate will likely be even lower.

One thing to watch for: if you’re a passive investor (meaning you weren’t hands-on in running the business), you might also owe the Net Investment Income Tax — an extra 3.8%. But if you were actively involved in the company, good news: that extra tax doesn’t apply.

And don’t forget about state taxes. Some states will want a piece of the pie, too.

If the Business Sells Its Stuff and Then Closes

Another very common route is for the S corporation itself to sell everything it owns — equipment, property, inventory — pay off any debts, and then distribute the leftover cash to you and the other owners. In tax speak, this is referred to as a liquidation.

Here’s how that plays out for taxes:

First, when the business sells its assets, it recognizes a gain (or loss) on the sale.

Because S Corps are pass-through entities, those gains (or losses) flow directly to your personal tax return when selling your S Corp.

You will receive a Schedule K-1 form from the corporation, which will show your share of the gains or losses, and you will report it on your 1040 tax return.

If the business is selling things it’s owned for more than a year, you generally get the better long-term capital gains rates. But there are exceptions. For example, gains from certain things, like equipment that’s been heavily depreciated, might get taxed at higher ordinary income rates. This all depends on your personal income for that year, which determines your individual tax bracket, up to 37%.

If you weren’t actively managing the business, the Net Investment Income Tax could apply again. If you were actively involved, you’re in the clear.

How the Final Cash Payout Gets Taxed

When selling your S Corp, the business first pays any outstanding bills, then it distributes whatever is left to you and the other shareholders. Tax-wise, this payout gets compared to your basis (your investment in the business).

If you get more cash than your basis, you’ll have a capital gain on the difference.

If you get less, you’ll have a capital loss you can potentially deduct.

If you’ve owned your stock from day one and kept your basis updated along the way, the cash you receive won’t usually match your basis, so you might have a big gain at the end.

Pro Tip When Selling Your S Corp: If you have suspended passive losses hanging around from previous years, you might finally be able to fully deduct them when you sell or liquidate your stock. That could help soften the tax bite.

Special Tax Rules Around Selling Assets

When the business sells its assets, it needs to assign a price to each thing it sells. This matters because different assets are taxed differently.

Land and buildings typically bring long-term capital gains.

Equipment, furniture, and other depreciated assets often generate gains that are taxed at ordinary income rates, either partially or fully.

Inventory and accounts receivable are treated like regular income, not capital gains.

There is a special form for this (Form 8594) that helps the buyer and seller stay on the same page regarding how everything was valued.

Watch Out for Real Estate Recapture

If the business is selling real property (like a building) that’s been depreciated, there’s a quirky rule called depreciation recapture. Some of the gain — up to the amount of depreciation taken — might be taxed at a higher rate, up to 25%, instead of the lower capital gains rate.

It’s not as scary as it sounds, but it’s definitely something you’ll want to plan for when selling your S Corp.

Section 1231: A Silver Lining for Business Owners

Here’s a silver lining: gains from selling business property (called Section 1231 gains) usually get the better long-term capital gains treatment. And losses? They’re treated as ordinary losses, which means you can deduct them against any type of income — salary, interest, you name it.

However, there’s a catch: if you had Section 1231 losses in the last five years, your current gains might get taxed at higher rates until you “pay back” those prior losses.

A Smart Tax Move: Negotiating the Sale Allocation

If you’re selling assets, you can sometimes negotiate how the purchase price gets split up among the different assets. Ideally, you want more value allocated to things that generate capital gains (like land and goodwill) and less to things taxed as ordinary income (like inventory).

Effective tax planning can significantly reduce your tax liability.

Other Things to Keep in Mind

If part of the sale deal includes a non-compete agreement — basically, a promise you won’t start a competing business — any money you get for that promise is taxed as ordinary income. The good news is that it’s not subject to self-employment tax.

Also, don’t forget that when your S Corp shuts down, it must file a final tax return and provide shareholders with final K-1s. The sale and asset allocation (Form 8594) must also be properly reported.

Bottom Line:
Selling or closing your S corporation is a big step, and the tax implications can be tricky — but with good planning, you can minimize the surprises and maximize what you keep.

S Corporation Tax Filing

Don’t forget that when selling your S Corp, you’ll have one final 1120S tax filing. This will include final Schedule K-1s for all shareholders.

You’ll also need to file Form 8594 with the S corporation’s final return to report asset allocations and any non-compete amounts.

Want a checklist that will make this whole process easier?