Will the sale of your business be treated as a stock sale or an asset sale? The great majority of transactions involving privately held companies are asset sales. This blog explains the reasons, the exceptions, and the tax consequences.

A CPA may advise their client to sell the stock of their corporation, since a stock sale will generally result in capital gains taxed at a 15% rate. Realistically, however, most buyers won’t agree to a stock sale. Buyers prefer instead to form a new corporation and then purchase itemized assets of the selling corporation, which can include both tangible and intangible assets.

There are two reasons why buyers prefer asset sales. First, they avoid the unintentional assumption of liabilities from the seller’s corporation, such as product liability, back taxes, employee claims, or practically any type of litigation involving past operation of the business. Second, they desire to “write up” the value of the assets purchased so that they will have greater tax deductions for depreciation and amortization. If a buyer purchases the stock of a corporation with assets that are fully depreciated or consist primarily of goodwill, there will be no opportunity for tax savings from depreciation and amortization deductions.

The assets that are usually transferred in asset sales include inventory, fixtures and equipment, the trade name, and goodwill. Accounts receivable may or may not be included in the transaction. Liabilities are usually not transferred, although a buyer who wants to acquire the accounts receivable may also agree to take accounts payable that are not past due. Cash is seldom included, although in middle-market transactions, a level of “working capital” required to operate the business may be defined in the purchase documents and included in the sale.

There are some instances in which buyers realize advantages to stock transactions. The business may have government licenses or product distribution agreements that are not transferable to a new corporation. For example, a buyer of a business that holds a Medicare reimbursement license will probably agree with the seller to structure the transaction as a stock sale. In this instance, there will be “representations and warranties” written into the purchase documents to protect the buyer from events that occurred during the seller’s period of ownership and visa versa.

Does the seller in an asset transaction lose favorable tax treatment? Not entirely. The buyer and seller must agree to an allocation of the purchase price to specific categories of assets and each report that allocation to the IRS on Form 8594, Asset Acquisition Statement. The part of the purchase price that is allocated to intangible assets such as goodwill still qualifies for capital gains treatment at a 15% rate.

The part of the price allocated to either not-to-compete agreements or equipment is likely to result in gains taxed at ordinary income rates. The buyer will prefer to weight the allocation toward equipment in order to benefit from five- to seven-year depreciation versus the 15-year amortization that applies to intangible assets.

Keep in mind that the transaction is only taxable to the extent that the sale price exceeds the seller’s cost basis. If a large part of the sale consists of inventory or equipment that has not been depreciated significantly, the seller’s gain on the sale will be considerably less than the sale price.

If it is of paramount importance for the seller to obtain 15% capital gains treatment on the entire sale, it may be possible to negotiate this with the buyer. For instance, the seller could respond to a buyer’s purchase offer by stating “I will accept a price of $X for an asset sale or a price of $Y for a stock sale.”

Both parties need to be aware that closing costs will be higher for a stock sale, since the transaction documents need to be drafted carefully by attorneys both to avoid issues with federal and state securities laws and to indemnify the parties from cross-ownership claims.

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