Whether the sale of a corporate business is cast in the form of a sale of assets by the corporation or a sale of stock by its shareholders can have strikingly different tax, as well as non-tax, consequences for the seller of the business. It is therefore important for the seller that the advantages and disadvantages of sale of assets, as compared with a sale of stock, be carefully evaluated. This evaluation should then be reflected in the negotiations with respect to both the method of sale and the price which the buyer is to pay for the purchase of the business.
The following checklist summarizes some of the more important factors to be considered when deciding between a stock sale and an asset sale.
Liquidation of Corporation Being Sold
A sale of assets followed by a liquidation of the corporate seller results in a double tax, i.e., the corporate seller will pay a tax on gain recognized on the sale, and the shareholders will pay tax on gain recognized on the liquidating distributions that they receive. A sale of stock avoids for the seller a double tax at the corporate and shareholder levels, resulting in a single tax to the selling shareholders on gain from the sale at capital gains rates.
Therefore, the double tax cost to the seller’s shareholders will usually mean that the seller will prefer a stock sale to an asset sale. The converse is true for the buyer who, in a taxable sale of assets, acquires the assets comprising the business with a basis equal to the price paid (including any liabilities assumed).
For example, in a sale of assets, if the depreciable assets are worth more than their basis to the seller, the buyer gets a stepped-up basis for the assets, and will therefore get higher depreciation deductions than the seller was enjoying. In a sale of stock, however, the basis of the assets to the corporation after the sale generally remains the same as it was before the sale, and thus, the buyer will often be willing to pay less for stock than for assets.
Seller’s Tax on Appreciation in Value of Stock Where Corporation Doesn’t Liquidate
In a taxable sale of assets, the shareholders may avoid income tax on the appreciation in value of their stock in the corporation by keeping the corporation in existence until the shareholder’s death at which time the stock passes to his estate or heirs with a stepped-up basis in their hands. In this way, all appreciation in value of the stock before death, including pre-sale appreciation will escape income tax on a later sale of the stock or liquidation of the corporation by the shareholder’s estate or heirs. (For a discussion of the personal holding company problems that may arise, however, if the corporation isn’t liquidated following the sale of its assets, see the discussion below.) In a sale of stock, avoiding income tax on the appreciation in value of the stock isn’t possible since that appreciation in value is reflected in the selling price and is taxed as capital gain to the shareholders for the year of sale.
Personal Holding Company Penalty Tax
In a taxable sale of assets, personal holding company problems can arise for the corporate seller, if the corporation isn’t liquidated after the sale. If the corporation retains and invests the proceeds of sale of the assets, it may be classified as a personal holding company and subjected to penalty tax on its undistributed personal holding company income. In a sale of stock, although personal holding company problems can arise for corporate selling shareholders which invest the sale proceeds, they cannot arise for individual selling shareholders.
Character of Seller’s Gain or Loss from the Sale
In a taxable sale of assets, the corporate seller must calculate various types of gain or loss because the characterization of the gain or loss realized from the sale of each asset as capital or ordinary depends on whether the asset is a capital asset, noncapital asset, or Code §1231 asset. The sale may trigger recapture, causing all or part of the gain to be taxed as ordinary income. Also, the original issue discount rules and the imputed interest rules may result in the recharacterization of certain gain as interest income.
In a sale of stock the seller’s (i.e., each shareholder’s) capital gain or loss is based on the difference between the basis of the shares and the sale price, and the shareholder generally will not realize the ordinary income that might be realized by the corporation from a sale of its assets.
Ordinary Income from Recapture
A taxable sale of assets may trigger various recapture provisions (e.g., depreciation, deductions for previously expensed items) causing the seller corporation to be taxed on ordinary income from the recapture. A sale of stock generally doesn’t trigger recapture provisions, and thus the burdens of recapture are shifted to the buyer.
Where one party to the proposed sale insists on a particular method of sale that eliminates his or her liability under recapture provisions, the other party may want to press for adjustment of the sales price to compensate for recapture liabilities which fall to him under that method of sale. For example, if a seller insists on a sale of stock rather than a sale of assets, the buyer, though preferring a sale of assets, could in order to preserve the deal, agree to buy the stock but press for a reduction of the sales price to compensate for the potential recapture liabilities which he acquires through a stock purchase.
Reporting Gain from Sale on Installment Method
In a taxable sale of assets, the corporate seller, which isn’t a dealer in property, may use the installment method to defer reporting gains on sales of assets other than inventoriable personal property, publicly traded stock, securities or other property. However, installment reporting isn’t available to defer dividend income, and the interest and pledge rules under Code §453A diminish some of the benefits available from installment reporting in certain sales involving a selling price of over $150,000. The interest rules apply by imposing an annual charge on the seller’s deferred tax liability if the total amount of all of the seller’s installment obligations receivable that arise during the year and are outstanding at the end of the year exceeds $5,000,000. Pledge rules apply to deter sellers from using installment obligations as security for debt incurred by the seller.
In a sale of stock. The seller’s shareholders, who aren’t dealers in stock and securities and who receive notes from the buyer, may usually report their gains on the installment method, except that installment reporting isn’t available for the sale of publicly traded stock. The interest and pledge rules also apply to stock sales.
Installment Obligations from Earlier Sales
A sale or distribution in liquidation of installment obligations received by the seller corporation in earlier sales of its assets accelerates reporting of gain from those earlier sales into the current year of sale of the corporate business. In a sale of stock, there is no acceleration of gain and the corporation continues to report the gain on a deferred basis.
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