One of the first and most important decisions in a business sale is how the transaction will be structured. At a high level, most M&A deals fall into one of two categories: an asset sale or a stock sale. While the distinction sounds simple, the tax treatment, risk allocation, and post-deal outcomes can look very different depending on which path is chosen.

What’s included in asset sales?

In an asset sale, the buyer is purchasing specific pieces of a business rather than the legal entity itself. That means the parties can be intentional about what is included in the deal. Core operating assets are typically part of the transaction, while items like personal assets, related-party balances, or other non-operating components may be left out.

After closing, the seller still owns the legal entity. What remains is usually cash from the transaction, any retained liabilities, and other assets excluded from the sale.

Why are asset deals favored by buyers?

Buyers are often drawn to asset deals for two main reasons: tax benefits and risk reduction. From a tax perspective, asset purchases allow for a “step-up” in the basis of the acquired assets. That step-up can increase depreciation and amortization deductions, improving after-tax cash flow over time.

Just as importantly, buyers can limit exposure to historical liabilities. Because they are not acquiring the legal entity itself, they are generally better protected from issues that may surface later, whether known or unknown at the time of closing. That combination of tax efficiency and risk control is why asset deals are frequently preferred on the buyer side.

Entity Structure Changes Everything

In a C-Corporation, an asset sale can trigger what is commonly referred to as “double taxation.” First, the corporation pays tax at the entity level on the gain from the sale. Then, shareholders pay tax again when proceeds are distributed. Even with the corporate tax rate being a flat 21%, the second layer of tax can still materially reduce what owners ultimately receive.

S-Corporations operate differently. As pass-through entities, income is generally taxed once at the shareholder level. While this avoids double taxation, asset sales can still create a mix of capital gain and ordinary income depending on the underlying assets. The result is that structure and tax classification can have just as much influence on deal outcomes as the purchase price itself.

S-Corporations that have converted from being a C-Corp to an S-Corp within 5 years prior to a sale can still face the negative tax consequences of being a C-Corp. This is because when a company converts to S-Corp status, the corporation is required to measure any built-in-gains (BIG) upon conversion, and if any of those BIG assets are sold within 5 years of conversion, then a 21% Federal “BIG” tax would be applied as if the company had remained a C-Corp. Any appreciation in the value of corporate assets after the conversion date is not subject to BIG tax.

Stock sales: selling the entity as a whole

In a stock sale, the buyer purchases ownership of the company directly from the shareholders. Operationally, this is often simpler. The legal entity remains intact, along with all assets, contracts, and liabilities. There is no need to retitle individual assets or reassign agreements in most cases. For sellers, stock sales are often attractive because they are typically taxed at capital gains rates and allow for a cleaner exit from ownership.

The buyer’s tradeoff in stock deals

While stock sales are administratively easier, buyers don’t receive the same tax benefits as they would in an asset purchase. There is generally no step-up in asset basis, which means future depreciation benefits are limited.

In addition, buyers inherit both known and unknown liabilities of the business. These risks can be managed through indemnities and purchase agreement protections, but they cannot be eliminated entirely.

The Section 338(h)(10) election

A transaction may land between an asset and stock sale when a buyer and seller agree to make a Section 338(h)(10) election. This structure allows the deal to be legally executed as a stock sale while being treated as an asset sale for tax purposes. In practice, that means:

• Buyers receive a stepped-up basis in assets
• Sellers are taxed as if the assets were sold directly
• The transaction avoids the need to retitle every asset individually

This can be especially helpful when contracts or licenses would otherwise be difficult to transfer.

Real-World Example

Imagine a manufacturing company with a $10 million valuation and tax basis of its assets as follows:

• $5 million of equipment that has been substantially depreciated ($1,500,000 tax basis)
• $1 million of inventory ($500,000 tax basis)
• $4 million of self-created goodwill ($0 tax basis)

In a stock sale, the seller's gain will qualify for capital gains treatment.

In an asset sale, part of the gain attributable to equipment depreciation recapture and inventory would be taxed as ordinary income, while only the goodwill portion receives capital gains treatment. The result could be hundreds of thousands of dollars in additional taxes to the seller.

For an S-Corporation, the difference between a stock sale and an asset sale is often less dramatic than it is for a C-Corporation, but the tax impact can still be significant depending on the purchase price allocation. That's why sellers should evaluate the after-tax proceeds, not just the purchase price, when comparing offers.

Example Details: S-Corporation Stock Sale vs. Asset Sale

Assume the same facts as the real-world example above. Additionally, assume the owner's stock basis is $2 million, the owner has held the stock for more than 1 year, and the state tax rate is 5%.

Why the Difference?

In a stock sale, the owner sells shares directly and recognizes capital gain. The buyer acquires the company as-is, including its assets and liabilities.

In an asset sale, the company sells its assets individually. While the gain still passes through to the shareholders, certain assets, such as equipment that has been heavily depreciated, can generate ordinary income through depreciation recapture. Since ordinary income is often taxed at higher rates than long-term capital gains, the seller may owe more tax even though the purchase price is exactly the same.

Partner with Lutz to Sell Your Business

At Lutz, our Tax and M&A services work together to help clients evaluate these decisions alongside their broader transaction strategy, so they can move forward with clarity and fewer surprises at closing. Contact us to learn more.