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Monday, May 6, 2024
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Case Studies |
S Corporation Converts to C for Bailout
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Case:
Bill Lee is age 64 and owns three car dealerships spread throughout the city. Founded in 1977, Bill and his wife Amy are sole shareholders of Lee Motorsports, Inc., an S corporation. The car dealerships represent mainly high-end, luxury car lines. Specializing in providing unparalleled customer service before, during and after the sale, Lee Motorsports has flourished and grown. It produces over $30 million annually in sales and consistently ranks among the best dealerships.
As long-time active members of the community, Bill and Amy are often seen at charity fundraisers and events. They both started with nothing and believe that now is the time to give something back. Bill is especially oriented toward supporting at-risk youth programs in the local community. In fact, Bill was an at-risk youth himself. Having run away from an abusive home at age fifteen, he actually lived on the streets for a brief time. Fortunately, he was befriended and taken in by volunteers of the local at-risk youth center at the age of sixteen. Through love, support and counseling, Bill turned his life around and the rest is "car" history.
Since Lee Motorsports, Inc. is such a desirable business and there are no comparable locations for new dealerships in the city, Bill knows that he can ask for favorable terms when he sells the business. In fact, he and Amy are ready to retire and move on with life focused on family and their favorite charities.
Question:
How should Bill and Amy structure the sale of LMI? Should they keep it as an S corporation or convert to a C corporation?
Solution:
Bill has been contacted by a very large company that is willing to make a large offer for his unique business location, clientele and operation. The offer is initially for the purchase of the assets of the S corporation. But Bill would like to sell tax-free through a charitable remainder unitrust and the S corporation stock cannot be transferred to a unitrust. In addition, transfer of part of the assets to a unitrust would cause potential UBI tax and operations problems while the business was still running.
Bill discussed the options with his CPA Susan White. She noted that if the buyer is willing to purchase a C corporation, it would be easy to change from S to C. After that change, they could use 70% of their stock to fund a unitrust and sell 30% outside the trust for cash. With the bypass of gain on 70% and the charitable deduction, there would be a tax-free sale of Lee Motorsports, Inc.
Bill discussed that option with the prospective buyer, but did not commit to a sale. Since the buyer plans to replace the current building with a major new car center, the buyer did not need the depreciation benefit on the current building and was willing to buy the C corporation. Therefore, Bill and Amy were able to convert from an S corporation to a C corporation and enjoy the benefits of a tax-free sale. After the conversion, they transferred 70% of their stock to a unitrust with CPA Susan as initial trustee. There was a joint sale of all stock to new buyer, and the S to C bailout plan worked very well.
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