Asset Sale vs. Stock Sale: Part One of Three
It is Not Always a Matter of Taxes
June 19, 2000 (SmartPros) An accountant will tackle few issues as complex as the sale of a business. Yes, tax considerations play an important role in negotiations, but so do a host of other issues. Legal liability, deeds and licenses, employee morale -- all of these factors will affect the deal's structure and, ultimately, how well your client makes out.
Despite the growing popularity of new types of corporate entities, such as limited liability companies, the vast majority of all business sales still occur between companies structured as corporations. In these cases, the sale is structured as either a sale of assets or as a sale of stock.
From a tax perspective, the vast majority of buyers will prefer an asset sale, and the vast majority of sellers will prefer a stock sale. For this reason, the asset sale vs. stock sale question often creates conflict between buyer and seller.
The Buyer's Choice
Exception: The buyer is still able obtain this "step up" in a stock sale by electing under IRC section 338, but the buyer will then be liable for the corporate level tax mentioned below.
For the seller, an asset sale creates a double tax situation. The entity being sold is taxed because of the appreciation of assets (tax No. 1), and, if the corporation is a C corporation (as opposed to an S corporation) and is liquidated, the seller must pay capital gains on the deemed sale of his/her stock (tax No. 2). If the deal is done as a stock sale, however, the seller will only pay once-on capital gains from the appreciation of stock.
Helping the Negotiations
For instance, in an asset sale, there are assets that can easily be transferred in a physical and legal sense, like furniture, computers, etc. However, legal transfer of assets can be much more complicated with items like automobiles, as the titles must be transferred at the DMV, or real estate, as deeds must be recorded with the local government.
The parties must also determine whether or not contracts can be transferred legally, and who will be responsible for future liabilities. The buyer may find that transfer of physical assets is so costly, time-consuming and/or problematic, that a stock sale, despite the lost tax benefits, is the path of least resistance.
On the other hand, the selling party may have its reasons for desiring an asset sale. One scenario in which a seller may avoid the dreaded double tax is if he/she as a shareholder has made personal loans to the company. The proceeds from the sale of the company's assets can be used to pay off the principal of the loan-and the seller receives that amount as a return of principal, which is not taxable. Exception: The seller can recoup his/her stock basis in the ordinary asset sale, thus avoiding incurring gain on the deemed sale of stock and the double tax, but, typically, the seller has a low or nominal stock basis.
Additionally, a stock deal transfers an entire company -- assets, employees, real estate - everything, including the kitchen sink. In certain cases, the seller may not want to sell everything. And the buyer may not want to buy everything.
For instance, often the seller wants to retain some of the corporation's real estate, either for other uses or to lease back to the buyer as an extra source of income. Often a buyer is interested in only a specific line of business. Unless the business already has a multi-level corporate structure, an asset deal is necessary in this scenario.
Exception: The seller can restructure the company at the time of the deal, but such a restructuring requires compliance with the complex, and fact specific, tax regulations regarding spin offs or split ups.
Whether buying a motorcycle or contracting a printer, there is a certain amount of give and take in any business transaction. Whether representing a buyer or a seller, be sure to examine all issues, tax-related or not, and fully understand the client's goals before you make a recommendation.2000, Smartpros Ltd. All Rights Reserved.