Last Updated October 22, 2022
When it comes time to sell your business, you will need to decide if you want to sell assets or stock. This is an important decision, as the tax consequences can be very different. In this blog post, we will discuss the differences between an asset sale vs a stock sale tax consequence. We will also provide some tips on what you need to know in order to make the right decision for your business. Keep reading to learn everything you need to know about the tax implications of selling assets versus selling stocks.
When it comes time to sell your business, you will need to decide if you want to sell assets or stock. This is an important decision, as the tax consequences can be very different. In this blog post, we will discuss the differences between asset sale and stock sale tax consequences. We will also provide some tips on what you need to know in order to make the right decision for your business. Keep reading to learn everything you need to know about the tax implications of selling assets versus selling stocks.
What is an asset sale?
Simply put, an asset sale is the purchase of individual liabilities and assets. During an asset deal, the buyer purchases physical and intangible assets of a company, such as fixtures, equipment, real estate, licenses, trade secrets, inventory, and telephone numbers. Meanwhile, the seller retains possession of the legal entity.
What is a stock sale?
In a stock sale, the buyer purchases the seller’s, or shareholder’s, stock directly by obtaining ownership in the legal entity. The liabilities and assets the buyer acquires during a stock deal are usually similar to that of an asset sale. However, if there are assets and liabilities the buyer does not desire, they will be paid off or distributed before the sale.
What are the tax consequences of an asset sale?
Asset sales typically result in expensive tax bills for sellers. Although intangible assets are taxed at capital gains rates, physical assets can be taxed at higher ordinary income tax rates, which depends on the seller’s tax bracket. Federal capital gains rates are currently 20%, and state rates vary. Some states have a 0% capital gains rate, while others are over 13%.
If the seller is a C-corporation, they will be subject to double taxation. The selling company is taxed when selling assets to the buyer, then again when the proceeds transfer outside the company.
In addition, if the seller is an S-corporation that meets specific requirements, the asset sale may be subject to corporate-level built-in gains tax. These requirements include:
- The business was formerly a C-corporation.
- The sale occurs within the first five years of switching to an S-corporation.
Due to tax advantages, buyers generally prefer an asset sale structure. According to IRS regulations, the buyer will receive a step-up in basis of the seller’s depreciable assets, meaning that the price paid for the asset is the new tax basis for the property.
If you’re a buyer, you can increase your tax deductions for depreciation, by allocating a higher value to assets that depreciate quickly. You can also increase your tax deductions for amortization, by assigning lower values to assets that amortize slowly.
Buyers also prefer asset sales because they can control which, if any, liabilities they will assume. Contingent liabilities, like employee lawsuits, can be particularly concerning. Buyers can also choose not to purchase certain assets. This should all be clear in the asset purchase agreement.
Tax consequences if the asset is held for less than 1 year
When an asset is sold after being held for less than a year, the seller must pay ordinary income tax, meaning they would be paying higher taxes. This can also result in double taxation for the shareholder.
Tax consequences if the asset is held for more than 1 year
The seller pays long-term capital gains tax on the proceeds if an asset is sold after being held for longer than a year. However, this can also be more complicated depending on how the assets and liabilities are transferred.
What are the tax consequences of a stock sale?
In a stock sale, a seller has to pay taxes on the gain in value for the stock they own; this is called a capital gain. You can calculate the capital gain by subtracting the initial purchase price of the stock, or cost basis, from the price for which the stock is being sold. A seller can pay two types of taxes on a stock deal: short-term and long-term capital gains tax.
Short-term vs. long-term capital gains
The length of time a stock is held before it is sold determines the type of capital gains tax that is incurred for the seller. If stock is held for less than a year before being sold, the seller will have to pay short-term capital gains tax, which will be taxed at the ordinary income tax rate. Long-term capital gains tax can incur if a stock is held for longer than a year and then sold. This is a different tax rate than the short-term rate, which generally results in fewer taxes. The highest long-term capital gains bracket in the United States is 20%, compared to 37% being the highest ordinary income tax bracket.
What is the difference between an asset sale and a stock sale?
The main difference between an asset sale and a stock sale is that asset sales involve buyers purchasing individual assets and liabilities from a seller. In contrast, stock sales involve buyers purchasing shares of stock within the company from a seller (meaning the purchaser will have legal ownership of part of the company).
This difference plays a crucial role in how a buyer or seller pays taxes and can also affect the risk to each party. For example, in an asset sale, buyers can avoid inheriting liabilities that could be tied to lawsuits or investigations. However, in a stock sale, the new owner is fully exposed to any future liabilities or risks that may be unknown at the time of stock purchase.
Which is better from a tax perspective?
Asset deals and stock deals both have unique advantages for the buyer and the seller. The better option from a tax perspective varies based on how a business is structured and several other factors. In general, sellers often prefer stock sales for tax purposes, while buyers usually favor asset sales.
Sole proprietorship
As a sole proprietor, there is no separation of assets like in a corporation. This means that any assets the business holds are the business owner’s personal property, resulting in fewer taxation layers from an asset sale. However, a sole proprietorship cannot be structured in a way to have stock, meaning the only option for selling as a sole proprietor is an asset sale. The only taxes business owners would need to pay are short-term or long-term capital gains on the assets being sold.
LLC
Like a sole proprietorship, an LLC cannot be structured to have stock in the company, meaning the only option to sell part or all of a company is an asset sale. The tax liability for an LLC in an asset sale is short-term or long-term capital gains from any sold assets.
C-corporation
A C-corporation is not a pass-through entity, meaning all taxes in a sale are paid by the company. In addition, C-corporations do not get preferential tax treatment, so all of the income for these corporations is treated like ordinary income with ordinary tax rates.
After a C-corporation sells its assets, the company will pay corporate taxes at a normal rate. The company must pay shareholders a dividend for the shareholders to receive the after-tax proceeds from the asset sale. The shareholders will then be taxed on the dividend at a capital gains tax rate. Because the C-corporation will need to pay both corporate taxes and the dividend to the shareholders, the company is subject to double taxation.
Whether a company is a C-corporation or S-corporation is irrelevant in the case of a stock sale. Because a stock sale occurs at a shareholder level, stock sales are usually more straightforward. Only two factors determine the taxable gain of a stock sale: the shareholder’s basis in the stock and the purchase price of the stock. The purchase price minus the basis equals the shareholder’s gain on the sale of stock. This is considered a capital gain; in turn, this will be taxed at a capital gains tax rate, typically lower and more advantageous than ordinary tax rates.
S-corporation
An S-corporation is a pass-through entity, so the shareholder pays taxes on the company’s income, rather than the company itself. The shareholders receive preferential tax treatment on a lower capital gains tax rate. However, different assets create different types of gains; some of these are capital gains, and some are ordinary. As a result, the price the shareholder has paid for an asset will affect the amount of taxes they pay.
What are the pros and cons of each (asset sale vs stock sale tax consequence)?
Here are the pros and cons of the tax consequences of an asset sale vs. stock sale:
Pros of an Asset Sale
- The buyer does not have to assume the liabilities of the target company.
- The buyer receives a step-up in the tax basis of acquired assets, so the buyer usually prefers this option.
Cons of an Asset Sale
- Transferring assets could be more complicated.
- The seller could receive a double layer of taxation.
- Agreements tied to certain aspects may need to be renegotiated.
Pros of a Stock Sale
- Money goes directly to shareholders.
- Transferring stock is less complicated than transferring assets.
- Sellers usually favor stock sales because the proceeds are taxed at a lower capital gains rate.
Cons of a Stock Sale
- The buyers could have more risk by buying the company’s stock, including all contingent risks that are undisclosed.
- Compared to an asset sale, a lower depreciation expense can result in a higher future tax for the buyer.
- Except for 338(h)(10) and 336(e) elections, there is no step-up in the tax basis of assets acquired.
Summary
An asset sale and a stock sale are both common methods of selling a company. An asset sale is when a company sells its assets, while a stock sale is when a company sells its shares. There are pros and cons to each type of sale when considering the tax consequence. It is important to consult with legal counsel to get proper legal advice when conducting the purchase or sale of a business.
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