Tuesday’s post discussed the tax implications to a buyer and a seller in an asset sale. Today we look at what happens in a stock sale.
If the business is structured as an S-corporation or a C-corporation, the seller and buyer can agree to a stock sale, whereby the legal entity is sold and the buyer gets all of the stock. Unlike an asset sale, stock sales don’t need to document the transfer of assets because the assets are (or should be) already owned by the corporation.
Tax Consequences
With stock sales, buyers don’t get a “step-up” in basis in the assets, because the assets have not been sold. The basis of the assets at the time of sale, or book value, sets the depreciation basis for the new owner. This means that the buyer doesn’t get the same depreciation benefits and thus may pay higher taxes than if the deal was structured as an asset sale.
Additionally, sellers often prefer stock sales because all of the proceeds are treated as capital gains, which usually means a significantly lower tax rate than if the proceeds were taxed as ordinary income.
Other consequences
Perhaps more importantly, buyers in a stock sale take on much more liability for unknown or potential claims against the business. These include future lawsuits, environmental cleanup responsibilities, payroll tax liabilities, employee claims, and other liabilities, all of which may become the responsibility of the new owner.
On the plus side for the buyer, a stock sale may be beneficial if the company has a few key vendors or customers, because there is less of a visible change in the company and thus less likelihood of losing critical business partners or accounts.
Stock sales require careful investigation by the buyer and accurate disclosures by the seller. Knowledgeable advisors regarding tax, legal, and other implications are critical to ensuring a successful transaction.