Buying or Selling Assets or Stock of a Corporation

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Potential buyers of a corporate business generally want to buy the assets of the corporation and not the stock.  Sellers generally want to sell the stock and not the assets.

When a seller sells stock of a corporation, the seller pays tax at capital gain rates on the gain recognized on the sale of the stock.  On the other hand, if the seller caused his or her corporation to sell its assets, then the corporation generally would have to pay tax at ordinary income tax rates on the depreciation recapture amount and tax at capital gains rates on the balance of the recognized gain.  And this corporate level tax is in addition to any tax the sellers pay upon distribution of the sales proceeds by the corporation to themselves.  So sellers generally prefer doing a stock sale because they pay less tax when the deal is structured as a stock sale.

On the other hand, a buyer wants to do a deal as an asset sale because the buyer avoids becoming liable for seller’s known and unknown liabilities, and because buyer will get an automatic basis step-up in the corporation’s assets.  As a result, the buyer will  get larger depreciation deductions and will pay less tax in the future.  For these reason, buyers generally insist on doing the deal as an asset sale.

Assuming taxes and existing liabilities are not a major concern, there are some situations where both buyer and seller would prefer to do a deal as a stock sale.  Doing a stock sale can eliminate the need to transfer or obtain new licenses, permits and certifications.  Doing a stock sale is somewhat less cumbersome since only title to the stock gets transferred and not all of the individual assets.

When buyer and seller negotiate the structure of the deal as an asset sale or a stock sale, they need to factor in the tax consequences when setting the agreed purchase price.  A higher purchase price will generally be paid by the buyer in an asset sale.  A lower purchase price will generally be paid by a buyer in a stock sale.

 But if a deal must be structured as a stock sale, is it possible for a buyer to do the stock sale and still get the tax effect of doing an asset deal?    It is.    IRC section 338(h)(10) permits a buyer and seller to jointly make an election to treat the stock sale as an asset sale for tax purposes.  If this election is made, only corporate-level gain on the deemed asset sale is recognized.  No shareholder-level gain is recognized on the actual stock sale.  Second, the deemed asset sale is treated as occurring while the target corporation is still a member of the selling group.  As a result, it is often possible for the seller to shelter the gain on the deemed sale of assets with operating losses or other tax benefits within the selling group.  As a result, an IRC section 338(h)(10) election may be agreeable to both parties when negotiating the structure of a deal if the value of the future tax benefits to the buyer (stepped up basis) exceeds the current tax cost to the seller.  To the extent the buyer gains significant basis step-up as a result of the election, buyer might increase the stock purchase price somewhat to account for the increased taxes paid by the seller.

If you have questions about making a 338(h)(10) election, call one of our business and tax attorneys at 937-223-1130 or jsenney@pselaw.com.



AND ONE MORE THING.  Don’t forget that making a 338(h)(10) election for an “S” corporation could cause the built-in-gains tax to apply.  BIG tax applies when an “S” corporation that was formerly a “C” corporation sells appreciated assets at any time during the recognition period.  If you have any questions about BIG tax please call one our tax and business attorneys at 937-223-1130 or Jsenney@pselaw.com.
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