How Deal Structure Affects Post-Sale Taxes
- Brandon Chicotsky
- Jan 13
- 12 min read
When selling a business, how you structure the deal - asset sale, stock sale, or other arrangements - can drastically impact your tax bill. The key takeaway? It's not just about the sale price but how much you keep after taxes. Here's what you need to know:
Asset Sales: Preferred by buyers due to depreciation benefits but often trigger double taxation for C Corporation sellers - corporate-level gains (21% federal tax) and shareholder-level dividend tax. Depreciation recapture can further increase the tax burden.
Stock Sales: Simpler for sellers, taxed as long-term capital gains (20% federal rate + 3.8% Net Investment Income Tax for high earners). Buyers may pass on stock sales unless contracts or licenses make this option necessary.
Section 338(h)(10) Elections: A hybrid option treating stock sales as asset sales for tax purposes. This can benefit buyers with depreciation but may increase the seller's tax liability.
Entity Type Matters: C Corporations face double taxation on asset sales, while pass-through entities (LLCs, S Corporations) avoid this but still face ordinary income tax on certain assets like inventory.
Planning ahead is essential. Early tax planning - 12–24 months before selling - can help you optimize the deal structure, reduce tax liabilities, and maximize your take-home proceeds. Strategies like converting a C Corporation to an S Corporation, leveraging Qualified Small Business Stock (QSBS) exclusions, or using F-Reorganizations can make a big difference. Always consult experts to navigate these complexities effectively.
Common Deal Structures and Their Tax Consequences
How you structure a deal significantly affects your tax obligations. From asset sales to stock sales and specialized elections, each approach carries its own tax implications.
Asset Sales vs. Stock Sales
A stock sale involves selling your shares to the buyer, transferring both the company's assets and liabilities. Tax-wise, this is typically simpler for sellers: the profits are taxed as long-term capital gains, capped at 20% federally, with an additional 3.8% Net Investment Income Tax for high earners. Stock sales are usually taxed only in the seller's state of residence [7] [9].
An asset sale, on the other hand, involves the corporation selling individual assets like equipment, inventory, or customer lists. This can be more complex for sellers, especially for C Corporations, as it often triggers double taxation: a 21% federal tax on gains at the corporate level, followed by taxes on dividends distributed to shareholders. Additionally, depreciation recapture applies, meaning any previously claimed depreciation deductions are taxed as ordinary income (up to 37%).
"The primary drawback for a seller is that an asset sale can result in higher taxes, because a portion of the sale proceeds of the transaction will be considered ordinary income rather than capital gains." – Mark Gallegos, Tax Partner, Porte Brown [6]
Despite the higher tax burden for sellers, buyers often prefer asset sales - especially in over 90% of C Corporation acquisitions - because they can benefit from depreciation deductions on the acquired assets. If a buyer insists on an asset sale, you can negotiate a higher purchase price, known as a "tax gross-up", to help offset the additional taxes.
Section 338(h)(10) Elections
A Section 338(h)(10) election offers a middle ground by allowing a stock sale to be treated as an asset sale for tax purposes. Under this election, the IRS views the transaction as though the corporation sold all its assets at fair market value and then liquidated. For S Corporation sellers, this means the gains flow through to your personal tax return, often avoiding double taxation, though the proceeds are split between ordinary income and capital gains.
This election requires agreement from both buyer and seller, with all S Corporation shareholders consenting. Additionally, Form 8023 must be filed by the 15th day of the ninth month following the acquisition. It's worth noting that this option is only available for S Corporations or subsidiaries in a consolidated group, and the buyer must be a corporation.
"The Section 338(h)(10) election gives the buyer the potential to have it both ways and still achieve that [step-up tax basis] advantage." – Mark Gallegos, Tax Partner, Porte Brown [10]
Because this election can increase the seller's tax burden, it's wise to negotiate a price adjustment to account for the added cost.
Triangular Mergers
Another option to consider is a triangular merger, which involves merging your company into a subsidiary of the buyer's corporation. This structure is particularly appealing in industries like healthcare and finance, where maintaining licenses and permits is crucial. It also helps preserve business continuity.
If the merger qualifies as a "tax-free reorganization" under the Internal Revenue Code, you won't face immediate taxes on the stock exchange. Instead, the tax liability is deferred until you sell the new stock. If it doesn’t qualify for tax-free treatment, however, the gain is taxed as a long-term capital gain. Like stock sales, triangular mergers typically involve a single layer of taxation at the shareholder level, avoiding the double taxation seen in C Corporation asset sales.
That said, triangular mergers come with some risks. The surviving entity inherits all liabilities of your company, including any hidden or undisclosed claims, making thorough due diligence a must. Additionally, shareholder approval is required under state corporate law, and dissenting shareholders may exercise appraisal rights. To ensure the deal aligns with your goals and maximizes after-tax proceeds, tax planning should begin as early as the Letter of Intent stage.
How Business Entity Type Affects Taxes
The structure of your business plays a key role in determining your tax obligations after a sale. Whether your business is a C Corporation, S Corporation, LLC, or partnership, the type of entity dictates whether you’ll face one layer of tax or two. Let’s break down how each structure impacts your tax outcome.
C Corporations and Double Taxation
C Corporations face what’s often called "double taxation" during asset sales. Here’s how it works: the corporation pays a flat 21% federal tax on any gains from selling its assets. Then, when those gains are distributed as dividends to shareholders, they’re taxed again - up to 23.8% (20% capital gains tax plus a 3.8% net investment income tax). Combined, this creates an effective federal tax rate that exceeds 38% [11].
Here’s the kicker: over 90% of C Corporation acquisitions are structured as asset sales [7]. This often puts sellers in a tough spot tax-wise. However, there are strategies to soften the blow. For instance, if your shares qualify under Section 1202, you might be able to use the Qualified Small Business Stock (QSBS) exclusion. This could allow you to exclude up to $10 million - or 10 times your adjusted basis in gain - from federal taxes [7][11]. Another option? Converting to an S Corporation well in advance of the sale. Doing so can help you avoid the 3.8% net investment income tax [2].
Pass-Through Entities: Partnerships and LLCs
Things look different for pass-through entities like partnerships, LLCs, and S Corporations. These structures avoid double taxation altogether, as gains and losses pass directly to your personal tax return. This results in just one layer of tax [1][11].
When selling assets, though, not all gains are taxed the same way. Gains tied to inventory or "hot assets" like unrealized receivables are taxed at ordinary income rates, which can go up to 37%. On the other hand, goodwill - a major component in many sales - is taxed at the lower capital gains rate, capped at 20% [11][12]. This is where negotiations come into play. It’s often in your best interest to allocate more of the purchase price to goodwill rather than inventory or depreciable equipment [11][2].
"The sale of an interest in a partnership is treated as a capital asset transaction... But the part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary gain or loss." – Barbara Weltman, SBA Blog Contributor [2]
For S Corporation owners actively involved in the business, there’s another perk: you might be able to sidestep the 3.8% net investment income tax on sale gains. This is a tax that C Corporation shareholders almost always have to pay [7][2]. For multi-million-dollar sales, this difference alone can lead to substantial savings.
Pre-Sale Restructuring to Reduce Tax Liabilities
Reducing tax liabilities starts with early planning. By evaluating your company's structure ahead of time, you can identify strategies that align with your business goals and prepare for restructuring methods that defer immediate tax burdens.
If you own a C Corporation, one option is converting to an S Corporation to avoid the 3.8% Medicare tax on net investment income [2]. Additionally, Qualified Small Business Stock (QSBS) under Section 1202 can be a powerful tool. If your stock qualifies and you've held it for at least five years, you could exclude between 50% and 100% of your federal taxable gain - potentially shielding up to $10 million or more from federal taxes [4].
For partnerships and LLCs, making a Section 754 election can increase your business's appeal to potential buyers. This election allows the buyer to adjust the tax basis of the entity's assets to match the purchase price, providing them with valuable depreciation deductions while keeping your immediate tax burden unchanged [4].
If you're an S Corporation owner planning to retain rollover equity, an F-Reorganization can be an effective strategy.
F-Reorganizations
For S Corporation owners who wish to keep some equity after selling - commonly referred to as "rollover equity" - an F-Reorganization offers a tax-efficient solution. This restructuring not only allows buyers to step up the asset basis for future depreciation but also enables sellers to defer taxes on the portion of the business they reinvest [13][18].
The process involves forming a new holding company, contributing your S Corporation shares to it, electing QSub status, and converting the entity into an LLC [13][16]. This entire procedure is tax-deferred, meaning no taxable gain is recognized during restructuring, and taxes are only due on any cash received upfront [15][16][13][18].
"By structuring a pre-sale S corporation F reorganization followed by an equity acquisition of the target business, buyer and seller may simultaneously accomplish several of their highest priority goals." – Adam P. Margulies, Farrell Fritz, P.C. [14]
Timing is everything. You must file Form 8869 (the QSub election) while the target company is still a corporation and before it converts to an LLC [16][17]. An F-Reorganization can also help avoid potential S Corporation disqualification, making the transaction smoother and less risky for everyone involved [13][18].
This approach provides significant flexibility. The buyer doesn't need to be a corporation, there's no requirement for an 80% acquisition, and your rollover equity remains tax-deferred [18]. As Andrew Rice, Managing Director of Transaction Advisory Services at Trout CPA, explains: "The flexibility offered by an F-reorganization makes it the superior structure for the vast majority of situations where both options are considered" [18]. This strategy complements other restructuring methods and ensures long-term tax efficiency.
What to Consider When Choosing a Deal Structure
When deciding on a deal structure, it's crucial to weigh tax considerations alongside buyer preferences, all while safeguarding the value you've worked hard to build. Striking this balance can help ensure a smoother negotiation process and a favorable outcome.
Start by evaluating your entity type and its tax characteristics. For instance, if you're operating as a C Corporation with Qualified Small Business Stock (QSBS) under Section 1202, a stock sale might allow you to exclude 50% to 100% of gains - provided you meet the asset thresholds and holding period requirements [8][4]. On the other hand, businesses with significant inventory or receivables may lean toward asset sales, which are taxed at ordinary income rates [2]. These foundational considerations can shape your discussions with potential buyers.
From the buyer's perspective, asset deals are often preferred because they allow for a basis step-up and selective liability assumption [19]. However, certain circumstances - such as the need to maintain critical contracts, licenses, or regulatory approvals - may call for a stock sale to preserve continuity [19]. Pete Miller, Shareholder at Clark Nuber P.S., emphasizes:
The tax structure of an M&A transaction is not merely a technical detail - it is a fundamental driver of deal value and risk allocation [19].
If the buyer insists on an asset-style transaction or a Section 338 election, you might negotiate a tax gross-up. This involves calculating the additional tax burden and requesting a price adjustment to offset the cost. Keep in mind, though, that a Section 338 election requires the buyer to acquire at least 80% of your stock [8][4][6]. Additionally, consider whether your business has valuable tax attributes like Net Operating Losses (NOLs) or tax credits. In a stock sale, these attributes typically transfer to the buyer, potentially making your business more appealing [19].
It's wise to involve advisors early in the process, ideally before signing a Letter of Intent, to avoid disputes over deal structure [20]. If you're working with God Bless Retirement, you can tap into their network of CPAs and tax advisors to identify the structure that optimizes your after-tax proceeds.
Conclusion
The structure of your business sale plays a crucial role in determining your after-tax proceeds. For instance, the difference between an asset sale taxed at ordinary income rates and a stock sale taxed at capital gains rates can result in substantial variations in what you ultimately take home [5][3].
As mentioned earlier, taxes are often the biggest variable in how much you retain after the sale. This makes early and thorough tax planning an absolute must before finalizing any deal.
Every transaction is unique, so seeking expert advice is essential to identify the best structure for maximizing your after-tax income. Barbara Weltman, a contributor to the SBA Blog, emphasizes this point:
A sale of a business is a highly complex matter from a legal and tax perspective. Don't proceed without expert advice [2].
Start your tax planning 12–24 months ahead of the sale. This gives you time to model different scenarios, organize your records, and implement strategies like F‑reorganizations or Section 338(h)(10) elections [5].
To navigate this process effectively, work with trusted advisors. God Bless Retirement specializes in connecting business owners with CPAs, tax advisors, and financial planners experienced in managing sales for companies with less than $25 million EBITA. These experts can clarify how your deal structure impacts your final proceeds, ensuring you negotiate wisely, structure the sale effectively, and maximize the rewards of your hard work.
FAQs
How does a Section 338(h)(10) election affect taxes for buyers and sellers?
A Section 338(h)(10) election allows a stock purchase to be treated as an asset purchase for federal income tax purposes, creating distinct tax implications for both buyers and sellers.
For buyers, this election offers a major advantage: it permits a step-up in the tax basis of the acquired assets to their fair market value. This adjustment can lead to larger depreciation and amortization deductions, which may help lower future tax liabilities.
On the seller's side, the election treats the transaction as if the company sold all its assets and then liquidated. This often results in capital gains treatment for the proceeds, which is generally more favorable than being taxed as ordinary income in a typical stock sale. That said, sellers must account for any built-in gains at the time of the transaction, which could impact their tax outcome.
Although the election can deliver meaningful tax benefits to both parties, it comes with strict timing and filing rules. Working with skilled professionals, like the team at God Bless Retirement, can help ensure the process is handled smoothly and aligns with your broader financial objectives.
What are the advantages of switching from a C Corporation to an S Corporation before selling a business?
Converting a C Corporation into an S Corporation before selling the business can lead to notable tax advantages. Unlike a C Corporation, where profits are taxed at both the corporate and individual levels, an S Corporation allows the gains from the sale to pass directly to shareholders. These gains are then taxed at the individual level, often qualifying for the more favorable capital gains tax rate. This structure helps sellers sidestep the issue of double taxation and typically reduces the overall tax liability.
Take goodwill, for instance. In many cases, this asset is taxed at the capital gains rate, which is generally lower than ordinary income tax rates. This difference can significantly increase the seller's take-home proceeds. That said, implementing this strategy requires precise planning, including meeting specific timing and qualification requirements. It’s crucial to work closely with a tax professional to navigate this process effectively.
How can a triangular merger help ensure business continuity after a sale?
A reverse triangular merger is a smart way for an acquiring company to merge a subsidiary into the target business while keeping the target’s legal entity intact. This setup allows the target to become a wholly owned subsidiary, ensuring its assets, contracts, and agreements stay within the original corporate structure. The big advantage? It often reduces the need for third-party consents and avoids triggering anti-assignment clauses. This means the business can keep operating under its current licenses, supplier agreements, and employee arrangements without any major hiccups.
What’s more, a triangular merger can be designed as a tax-free reorganization. This allows the seller to defer capital gains taxes while maintaining the target’s operations, brand identity, and management team. The smooth transition helps retain customer confidence and keeps employee morale high. For business owners aiming to minimize disruptions and hit their strategic objectives, God Bless Retirement provides expert advice to determine whether a forward or reverse triangular merger is the right move for their unique situation.