Introduction
In this month’s newsletter, we bring you part II of a two part series discussing the advantages and disadvantages of a stock versus an asset transfer of a company from the buyer’s and seller’s perspective. While Part I focused on the buyer, Part II focuses on the seller.
When a corporation is sold, the transaction may be structured as a purchase of the shareholder’s stock. In a taxable transfer of a business, generally the seller is concerned with the immediate tax consequences. As you will see, in most situations a stock sale yields the most favorable result for the selling corporation and shareholder.
Consequences of an Asset Purchase to the Seller Corporation
If the assets are sold, the selling corporation will recognize a gain or loss on the transaction just as they would in any ordinary sale, regardless of whether or not the sale is followed by a complete liquidation of the corporation.
If the sale is followed by a complete liquidation, a second tax to the shareholder will result.
Consequences of an Asset Acquisition to the Seller Shareholder
The tax consequences to the shareholders depend on the corporation liquidating after the sale of the assets. If the corporation liquidates after selling the assets, the shareholders will be taxed twice on the transaction. First, the corporation will be taxed on the sale of assets, then the shareholder will be taxed on the sale of the stock; typically at a capital gains rate.
If the corporation does not liquidate, its shareholders do not recognize any gain or loss on the transaction. A shareholder can avoid any shareholder-level gain by holding the stock until death, when their estate will take a stepped-up basis and the stock will be passed on to the deceased’s heirs.
In both situations, prior to this year, a gain could be deferred on the sale using an installment sale. However, Congress has since changed this rule to where all the gain on an asset sale will be recognized in the year of the sale. Thus, even if the payments are spread out over a period of years, the corporation is required to pay the tax in the year of the sale.
There are a few other problems that can arise during an asset sale to the shareholders. First, the assets left in the company will somehow have to be disposed of. Second, sellers may have to pay off liabilities not assumed by the buyers. Finally, the seller must recapture the depreciation on the assets the company sold, which will result in higher amounts of taxes paid by the corporation on the transfer.
Consequence of a Stock Acquisition to Seller
Stock sales provide the most advantageous result for the seller-corporation and shareholder. This is because the transaction is only taxed once funds are paid.
The shareholder will reduce their basis in the shares to zero and any excess price paid for the shares will result in a capital gains tax that will be paid at the appropriate rate by each shareholder. In the fashion, it is usually recommended to sellers that they sell their stock certificates in the company.
Conclusion
As can be seen, deciding if you want to sell assets or stock depends greatly on whether you are the buyer or the seller. If you are the buyer, the asset purchase will be more appealing; and if you are the seller, you would probably prefer to sell your stock. This becomes a key issue in negotiations when one decides to sell their company. If you are interested in purchasing a business or are considering selling a current business, contact the merger and acquisition specialists, at the Center of Financial, Legal, and Tax Planning, Inc. to devise a tax planning strategy that will fill your needs and successfully complete the transaction.
By: Roman Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors