Selling or Passing On the Business

A business is built to be sold, passed on, or left to compound, not operated indefinitely. The terminal transaction has its own tax structure, and the largest fights in any sale are about its shape.

Asset sale versus stock sale. In an asset sale, the buyer purchases the company’s assets individually and takes a stepped-up basis in them, which it can then depreciate — often immediately, under restored 100% bonus depreciation. Buyers favor this. Sellers usually do not: an asset sale splits the gain across asset classes, and the portion attributable to depreciated equipment is depreciation recapture, taxed as ordinary income instead of at preferential capital-gains rates. In a stock sale, the buyer purchases the ownership interest itself; the seller reports a single capital gain — eligible, if the conditions are met, for the IRC §1202 exclusion — and the buyer gets no step-up. Sellers favor stock sales for exactly the reason buyers resist them.

Three lines on the closing statement that are taxed differently from the rest. Whatever form the deal takes, both sides file Form 8594 allocating the price across the seven asset classes of IRC §1060, “Special allocation rules for certain asset acquisitions” under the residual method, and the two allocations must match — the buyer wants dollars in equipment and short-lived assets it can depreciate fast, you want them in goodwill taxed as capital gain, so the allocation is negotiated, not computed. A payment for your covenant not to compete is ordinary income to you and a fifteen-year IRC §197, “Amortization of goodwill and certain other intangibles” amortization for the buyer, so every dollar the buyer moves into the covenant costs you the capital-gains spread; price it or refuse it. And for a materially participating owner, gain on the sale of an S-corporation or partnership interest is tested through the entity under IRC §1411(c)(4) — the NIIT reaches only the slice attributable to assets that would have produced net investment income had the entity sold them — which is one more reason an active owner’s exit is worth structuring before the buyer structures it for you.

The middle ground the buyer will propose. The asset-versus-stock fight has a settled set of compromises, and you should know them before the letter of intent arrives. For an S-corporation or a corporate subsidiary, a joint IRC §338(h)(10), “Certain stock purchases treated as asset acquisitions” election — or its cousin under IRC §336(e) when the buyer is not a corporation — keeps the legal form of a stock sale while taxing it as an asset sale: the buyer gets the step-up, you still pay one level of tax, and the price of your consent is the recapture and any state tax the deemed asset sale triggers, which you make the buyer pay for in the purchase price. That state tax follows the business, not you: California treats a nonresident owner’s share of gain on a pass-through’s sale of business assets, a deemed asset sale included, as California-source business income apportioned by the entity’s factors ( 2009 Metropoulos Family Trust v. Franchise Tax Board, Cal. Ct. App. 2022), and Legal Ruling 2022-02 sources the hot-asset slice of a nonresident’s partnership-interest sale the same way; only the residual gain on the interest itself follows your residence. Private-equity buyers of S-corporations now prefer a pre-sale F reorganization: you drop the operating company under a new holding corporation that inherits the S election ( Rev. Rul. 2008-18), convert the old company into a disregarded LLC, and sell LLC interests. The buyer gets asset-sale basis, you can roll part of the proceeds into the buyer’s vehicle tax-free, and the S-election eligibility problems of the buyer’s fund never arise. For a C-corporation whose value sits in the owner’s own relationships and reputation, sell the personal goodwill separately: Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998), lets an owner who never assigned that goodwill to the corporation sell it directly, at one level of capital-gains tax, instead of routing it through the corporate asset sale and the dividend that follows. It requires that no employment or non-compete agreement ever transferred the goodwill to the company — check before the deal, because it cannot be unwound after. And one line that decides more than any election: IRC §1202 attaches to stock sold by the shareholder. An asset sale by the corporation, however it is papered, gets no exclusion.

The installment sale. Taking the entire price in one year can push a seller through the top of the capital-gains and ordinary brackets at once. The installment method ( IRC §453, “Installment method”) spreads the gain across the years payments are actually received, holding the seller in lower brackets — though depreciation recapture is still taxed in full in the year of sale, and interest applies to the deferred balance. Two limits bite at this reader’s scale. If the installment obligations you take back in a year exceed $5 million at year-end, IRC §453A, “Special rules for nondealers” charges you interest on the deferred tax attributable to the excess, at the underpayment rate, which converts the deferral from free to merely cheap. And pledging the note as collateral for a loan is treated as a payment under IRC §453A(d), so the buy-borrow-die pattern of section “Buy, Borrow, Die in Retirement” does not run through an installment note.

Succession. Passing the business to heirs is governed by the estate-planning tools in section “Estate planning” — the family limited partnership, valuation discounts for lack of marketability and minority interest, and trusts that keep the business out of probate. With the federal estate-tax exemption permanently set at $15 million per person ($30 million for a married couple), the planning emphasis for most owners has shifted away from estate-tax avoidance and toward the income-tax section “Capital Gains Resets With Inheritance” — structuring the transfer so heirs inherit the business at a stepped-up basis and shed its built-in capital gain. For an estate that is still taxable, the business itself buys time: IRC §6166, “Extension of time for payment of estate tax where estate consists largely of interest in closely held business” lets the executor pay the tax attributable to a closely held business in installments over as long as fourteen years, part of it at a subsidized rate (section “Paying the Tax on an Illiquid Estate”).