Asset Sale vs. Stock Sale: How the Structure Changes Your Taxes and Your Risk

Why buyers prefer asset sales

Tax. In an asset sale the buyer gets a stepped-up basis in the assets. The purchase price is allocated across equipment, inventory, and goodwill, and the buyer depreciates or amortizes those amounts going forward. Equipment can often be written off quickly. Goodwill is amortized over fifteen years. Those deductions are worth a lot to the buyer, and they do not exist in a stock sale, where the buyer inherits the company's old basis in everything.

Liability. In an asset sale the buyer takes only the liabilities they agree to assume, usually the lease, certain contracts, and sometimes accrued vacation. Old tax liabilities, lawsuits from before closing, warranty claims on past work, and unknown problems stay with the seller's entity. In a stock sale the buyer gets all of it, known and unknown, because the company that did those things is the company they now own.

Clean start. The buyer can form a new entity, set up new accounts, and begin with no history.

Why sellers sometimes prefer stock sales

Tax. In a stock sale the seller generally pays capital gains tax on the whole gain, at long-term rates, once. In an asset sale the seller's company sells the assets, and the tax depends on the entity type and the allocation. For a C corporation an asset sale can produce two layers of tax: the corporation pays on the gain, then the shareholders pay when the proceeds are distributed. For an S corporation or LLC there is one layer, but part of the gain may be taxed as ordinary income, including depreciation recapture on equipment and any amount allocated to a non-compete or consulting agreement.

Simplicity. In a stock sale the contracts, licenses, permits, vendor accounts, and employee relationships stay with the company and do not need to be assigned. For businesses with licenses that are hard to transfer, government contracts, or hundreds of customer agreements, that can be a deciding factor.

Liability. The seller walks away from the entity and its history.

How it usually gets decided

Most small business sales are asset sales. Lenders prefer them, buyers insist on them, and for S corporations and LLCs the seller's tax difference is often manageable. The seller's tax cost of an asset sale versus a stock sale is estimated by the seller's CPA before the business goes to market, so the seller knows what a stock sale would be worth to them and can negotiate.

When a stock sale matters to the seller, typically a C corporation with significant appreciation, the difference in after-tax proceeds can be large enough to justify a lower price. Some buyers will do a stock sale if the price reflects their lost depreciation and if the seller provides strong indemnities and an escrow for undisclosed liabilities. Some will not, and some lenders will not finance one.

For S corporations there is a middle path. A stock sale with a Section 338(h)(10) or 336(e) election is treated as a stock sale for legal purposes and an asset sale for tax purposes. The buyer gets the stepped-up basis, the contracts and licenses stay in place, and the seller's tax result is close to what an asset sale would produce. A 338(h)(10) election needs a corporate buyer. An individual buyer uses 336(e). Both apply to S corporations, since an LLC taxed as a partnership already gets asset-sale tax treatment on a sale of interests. It requires agreement from both sides, and it is worth asking about when license transfers are the obstacle.

Purchase price allocation

In an asset sale the price has to be allocated among asset classes on IRS Form 8594, and both sides file the same allocation. Buyers want more allocated to equipment and inventory, which they can write off faster. Sellers want more allocated to goodwill, which is taxed as capital gain, and less to equipment, which triggers depreciation recapture at ordinary rates, and less to non-compete agreements, which are ordinary income to the seller.

The allocation is negotiated, usually after the price is agreed and before the purchase agreement is signed. It is worth money on both sides and should not be left to the closing week. We address it in the letter of intent when it is likely to be contested.

What transfers and what does not

In an asset sale, every contract, license, permit, and account has to be assigned or reissued. The lease requires landlord consent. Customer contracts may require customer consent. Licenses such as a contractor's license, a liquor license, or a healthcare license have their own transfer process and timeline. Vendor accounts, merchant processing, software, phone numbers, and domain names all get moved. Employees are terminated by the seller and hired by the buyer, which has payroll and benefits implications.

In a stock sale, most of that stays put, though some licenses and contracts have change of control provisions that still require notice or consent.

The asset sale checklist is longer. Sellers who prepare it early, with a list of every license, contract, and account and what each requires to transfer, close faster.

Bulk sale and tax clearance

In California, an asset sale of a business's inventory and equipment can trigger the bulk sale law, which requires notice to creditors and, for deals of $2 million or less, an escrow claims process. It also requires tax clearance from the state agencies before the buyer is released from successor liability for the seller's sales tax, payroll tax, and income tax. These add time to closing and are handled by the escrow holder, but the seller has to have their filings current for the clearances to issue.

A worked example

An S corporation with $500,000 in SDE sells for $1.5 million in an asset sale. The allocation is $50,000 inventory at cost, $200,000 equipment, $20,000 non-compete, and $1,230,000 goodwill. The equipment was fully depreciated years ago.

The seller pays ordinary income tax on the $200,000 equipment recapture and the $20,000 non-compete, and long-term capital gains tax on the $1,230,000 goodwill. The inventory produces no gain. The buyer expenses much of the equipment in the first year and amortizes the goodwill and non-compete over fifteen years.

The same business sold as a stock sale at the same price produces capital gain on the full $1.5 million less the seller's basis in the stock, with no recapture. The seller saves the ordinary income tax on $220,000, which at combined federal and California rates might be $60,000 to $90,000. The buyer loses the first-year equipment write-off and the goodwill amortization, which over time is worth more to the buyer than the seller's savings, and inherits the entity's liabilities. Most buyers will not agree to that without a price reduction that exceeds the seller's tax savings.

The 338(h)(10) or 336(e) election on that same deal gives the buyer the asset-sale tax treatment, the seller the stock-sale tax treatment for most of the gain except that the recapture still applies, and both sides keep the licenses and contracts in place. When a business has a license or a contract that cannot be assigned, that structure is often the answer.

Liabilities that follow

In an asset sale, some liabilities follow the assets regardless of what the contract says. Unpaid California sales tax, payroll tax, and certain other tax obligations can attach to the buyer as successor unless clearance certificates are obtained, which is what the bulk sale and escrow process is for. Product liability for goods already sold, environmental contamination on the property, and certain employee claims can follow in some circumstances. Buyers protect themselves with representations, indemnities, and holdbacks. Sellers protect themselves by disclosing everything and having their filings current.

The practical answer

Assume an asset sale unless there is a specific reason for a stock sale, and know before listing what a stock sale would be worth to you after tax so you can price the difference. Have the CPA model both. Get the allocation into the LOI. Start the license and contract transfer list a year out.