The buyer is insisting on an asset sale to get a tax step-up in basis under Section 338(h)(10), but this will trigger significant tax liabilities for our shareholders compared to a straight stock sale. How do we calculate and negotiate a tax gross-up?

Question

Tyler Smith · Accepted Answer

An asset purchase agreement or a Section 338(h)(10) election allows the buyer to step up the tax basis of your assets, generating massive future depreciation deductions for them. However, for you, it often triggers ordinary income tax rates on depreciation recapture and inventory, which are much higher than capital gains rates. To handle this, you must run a parallel tax simulation. Calculate your net after-tax proceeds under both a stock sale and an asset sale scenario. The difference between those two numbers is the tax friction of the asset sale, and the buyer must cover it. Present this calculation to the buyer and demand a tax gross-up or equalization payment as a condition of agreeing to their structure. Frame this as a standard business practice. You are helping them secure a valuable tax asset, so they must compensate you for the tax penalty you incur to give it to them. Use your financial advisors to draft a clear allocation of the purchase price across different asset classes, minimizing ordinary income exposure where possible. If the buyer is unwilling to make you whole on an after-tax basis, insist on a straight stock sale. Never agree to a deal structure that leaves your shareholders with less cash in pocket than they originally negotiated.