We last discussed the taxation on the sale of a closely held business structured as a stock sale. This week, we discuss taxation on the sale of your closely held business’ assets.

In an asset sale, the buyer purchases only the agreed-upon assets (and perhaps some of the liabilities, though buyers often do not want to take on any of the business’ liabilities) the business and/or business owner want to sell.

While in the sale of a shareholder’s C Corporation stock the corporation may incur no tax itself, the shareholder(s) will, when the proceeds of the sale are distributed to them, become liable for taxes on capital gains, at long-term rates if their stock was held for over one year. The long-term capital gains rate is significantly lower than tax rates on ordinary income for individuals. The federal long-term capital gains rate tops out at 20%, while federal ordinary income tax rates rise to a top of 37%. This can represent a huge difference in the actual income tax liability incurred.

In an asset sale, a C Corporation will incur corporate tax liabilities on the sale profits at its corporate rate, a flat 21% for 2023. When the profits are distributed, shareholders are taxed at their long-term capital gains rates, providing their assets in the company have been held for over one year, rather than as ordinary taxable income. This double taxation of a C- corporation is one reason so many C Corporation owners push for a sale of stock, rather than assets.

Buyers, however, will under most circumstances prefer an asset sale, as they will receive a stepped-up basis in all assets acquired, which they do not under the rules governing stock sales. This reduces the buyer’s own tax liabilities by allowing them to deprecate or amortize the assets purchased in their new operating business.

Sellers of C-Corporations can use a buyer’s insistence on an asset sale to increase the selling price, due to the greater tax advantages to the buyer, and the significantly greater tax liabilities incurred by the seller in such a transaction.

Asset sales of S Corporations, however, can receive tax advantages above C Corporations’. An S Corporation is not a tax paying entity, but a tax reporting one. Profits and losses flow through to the shareholders’ individual income tax returns, and the taxes incurred are paid by those shareholders.

Example 1: Taxation of Asset Sale of a C Corporation

Example 2: Asset Sale of an S Corporation

The after-tax proceeds are, in this example, greater by $712,500 for the S Corporation sale as compared with the C Corporation sale..

Some C Corporations, therefore, look into converting themselves to S Corporations prior to selling the business. But – and this is a BIG ‘but’ – S Corporation assets inherited from a C Corporation and sold within 5 years of the conversion incur what is called the built-in gains (BIG) tax at the highest corporate rate, currently 21%. So if your business is a C Corporation, and you want the tax advantages of an S Corporation when that business is sold, you may want to plan well ahead, and wait out the 5-year period following the conversion before you sell.

By consulting closely with your Transaction Advisory Team, you may be able to leverage the buyer’s desire for an asset sale into a higher negotiated purchase price, in consideration of the far greater tax consequences to you in an asset sale compared with a stock sale.

To prepare for the inevitable tax consequences arising from the sale of your business – and to minimize them to the degree possible – employ the expertise of your Transaction Advisory Team, particularly your tax advisor(s). Remember, their wisdom and experience is why you chose them, so take full advantage of their knowledge.

If you are considering a potential sale of your business within the next decade, I recommend strongly that you consult with us.

Please click here to let me know how I can help you.

Until next time –

Peace,

Eric