Asset and Stock Acquisitions for Cash: Structural and Tax Differences

When buying or selling a corporate business, a business manager has a choice: is the transaction to be a purchase and sale of assets or a purchase and sale of corporate stock? The buyer of the assets or stock ("Buyer") and the seller of the business ("Seller") will be motivated to different answers to this question. The structure of these transactions and their tax consequences are summarized generally in this article. In later articles, we will explore other aspects of asset sale and stock sale transactions.

Asset Acquisition - Structure. In an asset deal Buyer buys the business’s assets (which may be all the assets of the Seller). Buyer will usually buy all operating assets of a business and may buy accounts receivable. For a number of reasons, Buyer may not want all corporate assets. The bulk sales act may apply to a purchase of substantially all of Seller’s assets, requiring notice to Seller’s creditors, and compliance can be time-consuming.

A usual reason for choosing the asset deal format is that Buyer seeks to avoid assuming all Seller’s liabilities, including unknown ones. Buyer may assume some liabilities (such as trade payables and accrued vacations) and avoid assuming others.

Another advantage in some situations is that usually Seller can do an asset sale without all its owners going along. (In a stock sale, however, Buyer usually wants 100%, and minority stockholders can have leverage that can be used to their advantage.) A disadvantage, however, is that Buyer often cannot automatically acquire contract or lease rights, franchises, or permits; it must negotiate with third parties and/or seek government approvals.

After a sale of all its assets, Seller will usually distribute the proceeds to its shareholders and dissolve. This will mean that Buyer will want to look to owners of Seller for any remedy if the assets purchased turn out to have been misrepresented.

Stock Acquisition – Structure. A stock purchase is simpler in concept than an asset purchase. Few distinctions (between wanted and unwanted assets or between assumed and un-assumed liabilities) need, or can, be made. Buyer buys all the stock of the corporation (sometimes called the "Target") and takes Target as it finds it. All Target’s assets remain subject to all Target’s liabilities. The bulk sales act does not apply. Many contract, lease, and franchise rights and permits remain in place (and in effect transfer automatically), although some sophisticated pre-existing agreements with third parties may require their consent to continuation after a transfer of control of Target.

Asset Acquisition - Tax Results. In an asset purchase, Buyer and Seller allocate the purchase price to the different assets, first to tangible assets, based on fair market value, then to intangibles other than goodwill, and finally to goodwill. The Buyer takes the assets with a tax basis equal to the portion of the purchase price allocated to them. This may be higher than their basis on Seller’s books, which means Buyer can depreciate or amortize the assets from that higher basis. Seller may concurrently have depreciation recapture.

If Seller has a gain on the assets sold, it will be ordinary gain or capital gain, depending on the asset. If Seller is an S corporation, this gain is taxed once (at the shareholder level). If Seller is a C corporation, however, this gain is taxed at the corporate level and then, when proceeds are distributed to Seller’s stockholders, typically in liquidation, they are taxed on any gain they have on the distribution to them. If Seller has net operating loss carryforwards, it can use them to offset its corporate level gain.

Amounts paid to Seller or its principals in exchange for a non-compete covenant or goodwill are amortizable by Buyer for tax purposes over 15 years. This 15-year period applies even if the amounts are paid out over a shorter period or at closing. In Maryland there will be transfer and recordation tax on real estate sold in an asset deal, and sales tax on personal property sold.

Stock Acquisition -Tax Results. Target’s stockholders will have a gain or loss on the sale of their stock, depending on their basis in their stock; usually this is a capital gain if stock has been held over a year. In a stock purchase, Target becomes wholly owned by Buyer, and Target’s tax basis in its assets is unchanged. Target continues to depreciate its assets at their old basis, and, of course, there is no depreciation recapture by Target. If Target has net operating loss carryforwards, their use after the acquisition is usually severely limited.

Any amount Buyer pays for Target’s stock in excess of Target’s basis in its assets is accounted for by Buyer as goodwill and subject to tax amortization over 15 years. Similarly, amounts paid to Target’s stockholders or executives in exchange for a non-compete covenant are amortizable for tax purposes over 15 years, regardless of when paid.

In a normal stock acquisition of a company, there is no transfer or recordation tax and no sales tax because neither the real estate nor personal property is sold to a new owner.

Conclusion. Choosing a form of transaction can have significant tax and non-tax consequences for both Buyer and Seller. Both Buyer and Seller should explore consequences of the transaction with professional advisors before proceeding.

If you want to learn more about buying and selling businesses, contact Lee Lundy at 410.752.9705 or via email.

This alert has been prepared by Tydings for informational purposes only and does not constitute legal advice.