Asset Sale vs. Stock Sale: Tax Issues

November 2013       Download PDF      Print

The tax consequences of the sale of assets versus the sale of stock can differ substantially. As a result, buyers typically prefer asset sales while sellers usually prefer stock sales. In this article, we will discuss the tax issues facing buyers and sellers of various entity types in both asset sale and stock sale transactions.

This article is not meant to provide tax or legal advice. We recommend that buyers and sellers consult with an attorney or tax advisor when considering how to structure a transaction.

Stock Sales

Stock sales of small privately held companies are relatively straightforward because the sale of stock occurs at the shareholder level. In a stock sale the shareholder is selling his personal shares of stock in the company to a buyer. Whether the company is a C corporation or S corporation is irrelevant in this case.

In a standard stock sale only two pieces of information are needed to determine the taxable gain: the purchase price of the stock and the shareholder’s basis in the stock. The purchase price less the basis equals the gain on the sale of stock to the shareholder. This gain is considered a capital gain and is taxed at the capital gains tax rate, which is usually lower than the ordinary tax rate. The example below illustrates the tax implications of a simple stock sale.

Tax Consequences of a Sample Stock Sale
Purchase Price $10,000,000 (A)
Less: Basis $3,000,000
Gain on Stock Sale $7,000,000
x Capital Gains Tax Rate (Est. Federal & State Combined) 30%
Capital Gain Taxes on Stock Sale $2,100,000 (B)
After-Tax Stock Proceeds $7,900,000 (A) - (B)

Special Provision for Stock Sales: 338(h)(10)

When selling shares of an S corporation, sometimes buyers and sellers will make what is known as a 338(h)(10) election. This election treats the transaction as if it were an asset sale rather than a stock sale. Although the shareholder sells stock to the buyer, he pays taxes as if he sold the company’s assets.

Asset Sales: C Corporations

While stock sales occur between the shareholder (the business owner) and the buyer, asset sales occur between the company itself and the buyer. C corporations are not pass-through entities, meaning that the company pays taxes on its income. This differs from pass-through entities, such as S corporations, in which the shareholder pays taxes on the company’s income. Moreover, C corporations do not get preferential tax treatment. This means that all income for C corporations is treated as ordinary income and taxed at ordinary rates, as opposed to capital gains, which are taxed at the preferential (lower) capital gains tax rate.

After the sale of assets by the C corporation, the company pays corporate taxes at the ordinary rate. In order for the shareholders to receive the after-tax proceeds from the sale of assets, the C corporation must then pay a dividend to them. This dividend is taxable to the shareholder at the capital gains tax rate. The payment of taxes by the company on the sale of assets and subsequent payment of taxes on the dividend to the shareholders is known as double taxation. The example below illustrates the tax implications of a simple asset sale by a C corporation.

Asset Sale Example: C Corporation
Purchase Price $10,000,000 (A)
Less: Asset Basis $5,000,000
Gain on Sale of Assets $5,000,000
x Ordinary Tax Rate (Est. Federal & State) 45%
Ordinary Taxes on Asset Sale $2,250,000 (B)
After-Tax Asset Sale Proceeds/Dividend Payment $7,750,000 (A) - (B)
x Capital Gains Tax Rate (Est. Federal & State) 30%
Capital Gain Taxes on Dividend Payment $2,325,000 (C)
After-Tax Asset Sale Proceeds $5,425,000 (A) - (B) - (C)

Asset Sales: S Corporations

As we mentioned above, S corporations are pass-through entities, which means that the company itself does not pay taxes on the sale of its assets. Rather, the income from the sale of its assets passes through to the shareholder, who is responsible for paying taxes. Individuals, such as shareholders, do receive preferential tax treatment and thus prefer the lower capital gain tax rate over the higher ordinary rate.

The sale of different assets results in different types of gains (some capital and some ordinary). Consequently, the price paid for each asset impacts the amount of taxes paid by the shareholder of an S corporation. The example below illustrates the tax implications  of a simple asset sale by an S corporation.

Asset Sale Example: S Corporation
Purchase Price     $10,000,000 (A)
Less: Asset Basis     $5,000,000
  Ordinary Capital Total
Gain on Sale of Assets $4,000,000 $1,000,000 $5,000,000
x Tax Rate (Est. Federal & State) 45% 30%  
Taxes on Asset Sale $1,800,000 $300,000 $2,100,000 (B)
After-Tax Stock Proceeds/Distribution     $7,900,000 (A) - (B)

Contact Us

  • If you have any questions about deal structure or selling a company, please contact:

    David Holzman, CFA
    President
    david@alliedbizgroup.com