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Overview of Deal Structures When Selling a Business – PART 1(Tax Consequences)

26thAugustOverview of Deal Structures When Selling a Business – PART 1 (TaxConsequences)

Posted by Trevor Crow

For business owners, the sale of their business will likely be one of the largest events they encounter duringtheir lif e. Accordingly, the business owner should take the time to understand the process with the guidance ofan expert who has experience with business sales to reduce the risk and maximize prof it. In this two-partseries of posts, I examine the most common types of deal structures that business owners use when sellingtheir businesses. Throughout this series of posts I ref er to stock generically as the representation ofownership interests in the business, but the same concepts apply if you’re dealing with membership interests ina LLC.

While there are many variations of deal structures available, the vast majority of deals f all under one of twobroad categories that are addressed below: (1) asset sales; and (2) stock sales. One of the main f actors toconsider when deciding between an asset sale and a stock sale is the tax consequences.

Asset Sales

An asset sale results in the best tax benef it f or the buyer. In an asset sale, a buyer purchases only the assetsof the selling business that it agrees to purchase and the price paid is allocated among each of the purchasedassets. Buyer ’s tax basis in all the purchased assets will be equal to the total purchase price. And the Buyer ’sbasis f or each asset will be the amount that the parties agree to allocate to each of the assets purchased(provided the allocation is reasonable). In general, the Buyer will want to allocate the most money to assetsthat depreciate on the shortest depreciation schedule. An asset sale will benef it the buyer when takingdepreciation and will also benef it the buyer when there is a subsequent sale of the assets purchased.

On the other hand, the tax consequences to the seller in an asset sale are not as f avorable. If the seller is a Ccorporation f or example, then the gain f rom the asset sale will be taxed at the corporate level f or f ederalincome tax purposes, and then the remaining cash lef t in the company will be taxed to shareholders of thecompany when the proceeds of the sale are distributed as dividends. If the entity is an S corporation or anLLC, there will usually be only one level of tax in an asset sale because these entit ies are considered pass-through entit ies f or tax purposes. However, as explained below the tax treatment to the seller in a stock saleis usually more benef icial to the seller regardless of seller ’s f orm of entity.

Stock Sales

A stock sale is typically benef icial to the seller. In a stock sale, the buyer will get a basis in the stock, whichcan’t be amortized, but typically does not get an increased basis in the purchased assets (unless the buyermakes a Section 338(h)(10) election, which is outside the intended scope of this post). With a stock sale, theseller ’s entity type doesn’t matter because the shareholders will only be subject to one level of taxation andtypically at lower capital gains rates. While the lower capital gains rates make a stock sale benef icial to all

f orms of seller entit ies, of ten a stock sale is not seriously considered as an option unless the seller is a Ccorporation and subject to the double taxation that occurs if the sale is structured as an asset sale.