Buying and selling a business happens every day in every industry, yet many don’t understand the fundamental parts of the transaction.
There are two ways to complete the transaction from a tax perspective; stocks or assets.
Stock (or ownership interest) sale
If the seller is a C or S corporation, a partnership, or a limited liability company (LLC) being treated as a partnership for tax purposes, the buyer can directly purchase the ownership interest. The Tax Cuts and Jobs Act (TCJA) has made buying the stock of these businesses more appealing.
There is a now permanent 21% corporate federal income tax rate for C corporations under TCJA. This will generate more after-tax income while the corporation pays less tax, and any appreciated corporate assets that have built-in gains will be taxed at a lower rate when sold.
For S corporations, partnerships, and LLCs there is a reduced individual federal tax rate because of TCJA. Passed-through income will be taxed at a lower rate on the buyer’s return, but these rates are scheduled to expire at the end of 2025. Washington may decide to extend after 2025 or eliminate before the end of 2025, other future changes will decide this.
An asset sale transaction is completed by a buyer purchasing the assets of a business. This would be the only option if the seller is a sole proprietorship or a single-member LLC being treated as a sole proprietorship for tax purposes. This can also be chosen if there are specific assets or product lines the buyer wants from the seller.
It should be noted that in some circumstances by making a Section 338 election, a stock purchase can be treated as an asset purchase.
Buyer vs. Seller
A buyer is more likely to want an asset purchase as the primary goal is to limit exposure to any unknown or undisclosed liabilities and minimize taxes after the deal is closed. They want to generate enough cash flow from the business purchased to cover any payments such as acquisition debt and get an acceptable return on investment.
The buyer can increase the tax basis of purchased assets, commonly known as a “step-up”, to reflect the purchase price. Stepping up the basis lowers taxable gains when assets like receivables and inventory are sold or converted to cash. It also affects depreciation and amortization deductions by increasing them for qualifying assets.
On the other hand, sellers commonly prefer stock sales. They generally want to minimize the tax bill from a sale which, compared to an asset sale, is more likely. Liabilities usually transfer to the buyer and assuming the interest has been held by the seller for over a year, any gain on sale is normally treated as a lower-taxes long-term capital gain.
There are other areas to consider when going into these transactions, such as employee benefits, as they can cause unexpected tax issues.
At the end of the day, it is recommended to ask a professional tax advisor how to proceed with negotiations to favor you whether you’re the buyer or seller. You don’t want to wait too long and miss out on the best tax results.