Corporate Tax Implications of Stock vs. Asset Sales

Choosing between selling corporate stock or selling the underlying assets changes cash taxes, basis adjustments, and post-closing compliance for both buyer and seller, so deal teams model each path before signing the letter of intent.

A stock sale transfers ownership; an asset sale transfers selected assets and liabilities.

In a stock sale the buyer steps into the target’s entity, assuming its basis in assets, NOLs, and exposures. In an asset sale the buyer picks specific assets, may leave unwanted liabilities behind, and records new stepped-up tax bases.

The seller prefers a stock sale to minimize double taxation on built-in gains at the corporate and shareholder levels, while buyers often pursue an asset deal for fresh depreciation and amortization deductions.

Seller’s tax outcome hinges on entity type and built-in gain.

C-corporation shareholders recognize capital gain on stock, yet the corporation’s inside basis stays unchanged—no corporate-level tax when only stock changes hands. In an asset sale the corporation recognizes gain on each asset exchanged, pays entity-level tax, then distributes proceeds, producing a second layer of shareholder tax.

For S-corporations the pass-through nature eliminates the second layer, so asset gains flow directly to shareholders. However, built-in gains tax may apply when the S-election is less than five years old.

Buyer’s cost-recovery benefits favor an asset purchase.

A fresh basis in tangible assets produces accelerated deductions; a new basis in intangible assets amortizes over fifteen years under § 197. No step-up arises in a straight stock sale—future depreciation follows the target’s historic basis.

Section 338 elections let a stock buyer mimic an asset purchase. A § 338(h)(10) election, available for qualified stock purchases of S-corporations or subsidiaries in consolidated groups, treats the target as selling assets while the buyer acquires stock; gain is pushed inside, still single-layer for S-corps, while consolidated groups absorb taxable gain against NOLs. A § 338(g) election applies when the target is not in a consolidated group, pushing tax inside the target and leaving buyers free from immediate tax.

Purchase-price allocation governs asset-deal tax basis.

Section 1060 and the residual method place consideration into seven asset classes: cash, marketable securities, accounts receivable, inventory, tangible property, amortizable intangibles, and residual goodwill. Buyers and sellers file Form 8594 to report identical allocations. Misalignment invites IRS challenge and potential purchase-price shifts.

Negotiations often center on goodwill versus tangible allocation: a higher goodwill share yields fifteen-year amortization for the buyer but capital-gain rates for the seller; shifting value to inventory yields faster deductions for the buyer but ordinary income for the seller.

Journal entry — purchase of assets with step-up.

Buyer pays $200 million for assets fair-valued at $160 million net of liabilities; difference recorded as goodwill.

Dr Inventory $25 000 000

Dr Plant and Equipment $85 000 000

Dr Customer Relationships $30 000 000

Dr Goodwill $60 000 000

Cr Cash $200 000 000

Tax basis equals book basis on day one, launching depreciation and amortization schedules. Deferred taxes arise only if book lives diverge from tax lives in later periods.

Liability treatment differs between deal forms.

In a stock deal existing liabilities remain; contingent obligations stay with the entity unless contractually indemnified. Asset deals legally require assumption agreements; excluded liabilities stay with the seller. Buyers discount purchase price for pension deficits, environmental exposures, and uncertain tax positions that would otherwise trail in a stock acquisition.

State income, sales, and transfer taxes shift economics.

Asset transfers may trigger bulk-sales notices, real-estate transfer taxes, and sales-tax on tangible personal property. State conformity to § 338 varies; some deny step-up, dampening projected state depreciation benefits. Sellers weigh franchise-tax exit charges when dissolving a remnant shell after an asset sale.

Financial-statement impact under ASC 805 and IFRS 3 diverges by structure.

A stock purchase applies acquisition accounting: purchase consideration compared with fair value of identifiable net assets yields goodwill. No new deferred tax on inside basis if no § 338 election. An asset purchase records assets at stepped-up book and tax bases, so deferred taxes are minimal at closing. Future impairments of goodwill will not lower taxable income, adding permanent differences.

Earn-outs and working-capital true-ups interact with tax allocation.

Post-closing contingent payments tied to revenue or EBITDA increase purchase price; in an asset deal they attach to Class VII goodwill for tax, extending amortization. In a stock deal they adjust stock basis only, offering no deduction without § 338 relief. Parties draft earn-out mechanics with tax impact in mind.

Deal modelling: balancing seller’s capital-gain preference against buyer’s basis-step-up value.

Buyers raise bids in stock deals when step-up is unavailable, reflecting the present value of lost deductions. Sellers drop prices for asset deals once their inside gain tax is quantified. Bridging this valuation gap often requires partial step-up through § 338 elections, installment notes, or pre-close asset drops into single-member LLCs.

Meticulous valuation, purchase-price allocation, and election planning ensure that both parties capture intended tax benefits while avoiding unexpected entity-level tax or disallowed step-ups.

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