The buyer insists on an asset purchase to get a step-up in basis, while we planned for a stock sale to avoid double taxation on our corporate assets. How do we calculate and negotiate a tax gross-up to keep our net proceeds whole?

Question

Tyler Smith · Accepted Answer

Buyers prefer asset sales because they can step up the tax basis of your acquired assets and depreciate them over time, while shielding themselves from unknown historical legal liabilities. For sellers structured as C-corporations, or S-corporations with significant depreciation recapture, an asset sale triggers severe tax consequences.

To negotiate a gross-up, you must model net proceeds on a cash-to-seller basis. Calculate the exact tax liability of a stock sale, which is generally taxed at favorable federal and state long-term capital gains rates. Next, calculate the tax liability of an asset sale, factoring in ordinary income tax rates on depreciation recapture, inventory, and potential corporate-level taxes.

The difference between those two outcomes is your tax penalty. Your negotiation position is straightforward:
- The purchase price must be grossed up dollar-for-dollar so your net after-tax proceeds equal what you would have received in a stock sale.
- Alternatively, negotiate an Internal Revenue Code Section 338(h)(10) election for an S-corporation, which treats a stock sale as an asset sale for tax purposes, provided the buyer pays the complete gross-up amount.
- Require the buyer to agree to the formal purchase price allocation under Section 1060 during the Letter of Intent stage, pushing maximum value into goodwill rather than heavily recaptured fixed assets.

Do not sign an LOI specifying an asset sale without locking in the gross-up mechanics. Once exclusivity begins, you lose your leverage to claw back that tax difference.