Sale of a C Corporation – Buy and Sell Tax Implications for Stock & Asset Sales

By Oren Glass, Partner

More than 90 percent of acquisitions of C corporations are structured as asset sales. While stock sales occur between the stockholder (business owner) and the buyer, asset sales occur between the company itself and the buyer. The differences in tax implications for the type of sale for each party could be substantial. The structure of the type of sale is often negotiated between the two parties when determining a sales price, as they should, hopefully, each be factoring into the equation the tax advantages and disadvantages of each type of sale. Read on for considerations for each type of sale involving a C corporation.

Stock versus Asset Sale – The Basics

This article discusses the differences between stock sales and asset sales, but first, let’s set out what qualifies in each category. While it may sound like a simple difference (i.e., a sale of stock is a stock sale, a sale of assets is an asset sale), it is important for both buyers and sellers of any type of business entity (not only C corporations) to understand that when they hear the term “asset sale,” it is not necessarily limited to a transaction with a “pure” sale of company assets. Asset sales can cover a range of transactions. For instance, there is the option for a transaction to be consummated as a stock sale for legal purposes, but with an election that can be made to be treated as an asset sale for federal tax purposes (subject to certain criteria). Two examples of this are the elections under IRC 338(h)(10) and 368(a)(1)(f) (F Reorganizations).

These elections are beyond the scope of this article, but it is important to note it allows what are stock sales for legal purposes to be treated as asset sales, allowing for buyers the tax advantages of an asset sale. For instance, both elections allow the purchaser to step up the value of the assets acquired in the transaction to fair market value. When these elections are made, the tax advantages it provides to one party are usually tax disadvantages for the other party. However, this tax differential is almost never equal. This differential creates ample opportunity for careful tax planning within the context of a transaction to achieve the most tax-efficient result.

Stock Sale: Generally Favored by the Seller

Advantages for the Seller

This type of transaction avoids the dreaded concept of corporate double taxation. The gain on sale is taxed only once at the owner’s individual level (on their individual income tax return) for the gain on sale of the stock, just as they would be with a gain on sale of any publicly traded security (e.g., Amazon, Google, Apple, etc.). There is no corporate-level gain. The gain on sale included on the seller’s individual tax return is considered capital in nature, and so it is eligible for the preferential capital gains tax rate that reaches a maximum of only 20 percent. This can be as much as 17 percent lower than the top ordinary income tax rate of 37 percent. However, it should be noted that the gain is also subject to the 3.8 percent net investment income tax for a maximum total federal tax rate of 23.8 percent (thereby reducing the differential from the ordinary income tax rate to 13.2 percent).

The sale of the company stock eliminates any potential future liability attributable to the previous owner (the current seller) before the sale of the company (that becomes a known issue after the sale). This becomes the responsibility of the buyer.

Disadvantages for the Buyer

The purchase of the company stock does not allow for any “step-up” in the tax basis of the value of the assets purchased, and so the buyer does not get additional depreciation deductions (such as for the acquisition of company goodwill). Instead, all consideration paid is deemed as additional cost basis, which will only be factored in upon the buyer’s subsequent sale of the company (and reduce their potential capital gain then). The buyer only receives the seller’s carryover basis of the fixed assets.

The purchase of company stock opens up the buyer to liability for issues that are attributable to the company for the time when owned by its previous owner (the seller). However, if there are potential exposure items that are known and properly disclosed in the due diligence phase of the deal by the seller, this can and should be negotiated as a reduction of the purchase price by the buyer. Alternatively, the sale terms may include the set up of an escrow account where a portion of the selling price cannot be immediately collected by the seller. It becomes contingent on the exposure items first being resolved, which would utilize the escrow funds if needed. Once all items are resolved, the remaining funds, if any, in the escrow account will be disbursed to the seller.

Asset Sale: Generally Favored by the Buyer

Advantages for the Buyer

The buyer receives a “step-up” in tax basis to the fair market value of the company’s fixed and intangible assets. Subject to other conditions, the step-up for fixed assets can generate significant depreciation expense, as they are eligible for 60 percent bonus depreciation in 2024 (which will be reduced to 40 percent in 2025, 20 percent in 2026 and is currently set to expire after 2026). Learn more about the phase-out of bonus depreciation and its effect on your business here.

A purchase price allocation will be prepared and agreed upon by both parties, and the depreciation and amortization of each asset, if any, depends on what type of asset classes each asset fits into. However, it is important to note that any amount allocated to goodwill is deductible as amortization over a 15-year straight-line useful life.

Additionally, all potential liabilities attributable to the company prior to the sale date are not the responsibility of the new owner (the buyer). They remain the responsibility of the previous owner (the seller).

Disadvantages for the Seller

The sale causes two levels of taxation. The seller is taxed first on the entity level as a gain on the sale of the company’s assets, which is taxed at a flat federal corporate tax rate of 21 percent. Then, when the seller distributes out the cash proceeds from the sale, they are subject to a second tax at the individual level as dividend income (which will also be subject to the net investment income tax of 3.8 percent).

It is important to note that there are certain steps a business could take to mitigate double taxation in an asset sale, but they require advance planning. One primary strategy is through the Qualified Small Business Stock Exclusion (QSBS), but that is beyond the scope of this article.

State Tax Implications of Stock versus Asset Sales

Generally, like for federal tax purposes, the state tax implications are much more advantageous for the seller in a stock sale. This is especially the case where the seller lives in a low- or zero-income tax state, since, generally, the sale of company stock is only taxable in the resident state. Conversely, generally an asset sale will be taxable to the selling business in all states the business operates in and has income tax nexus.

Wrap-Up

As one can see, there can be major tax implications for both the buyer and seller based on the structure of a sale of a C corporation. Therefore, it is critical that anyone contemplating the sale of their C corporation or the purchase of one consult their tax advisor. A tax advisor should collaborate with their client’s attorney on the transaction. This will ensure all tax implications are accounted for to generate the most tax-efficient result for their client.

Contact Us

If you have questions, contact your PKF O’Connor Davies client service team or:

Oren Glass
Partner
oglass@pkfod.com