The buyer is pushing for an asset sale or a Section 338(h)(10) election to get a step-up in asset basis, but we converted from a C-corp to an S-corp four years ago and are subject to Built-In Gains (BIG) tax. How do we negotiate a gross-up and structure the indemnity to protect us?

Question

Tyler Smith · Accepted Answer

If you converted your business from a C-corporation to an S-corporation within the last five years, you are in the built-in gains tax recognition period. If a buyer insists on an asset sale or a Section 338(h)(10) election to get a step-up in asset basis, this structure will trigger double taxation on your appreciated assets. To protect your net proceeds, you must negotiate a purchase price gross-up clause. This clause forces the buyer to increase the total purchase price to fully offset the extra tax liability you incur from the asset structure compared to a standard stock sale. To win this negotiation, you must present a detailed tax run-model prepared by your CPA. Show the buyer the exact dollar amount of the tax friction. Emphasize that the step-up in basis provides them with significant future tax write-offs, which has a tangible net present value. They must share that financial benefit with you. Furthermore, you must structure the indemnity provisions to prevent the buyer from clawing back the gross-up amount through post-close adjustments. Ensure the purchase agreement explicitly states that the tax gross-up is non-refundable and excluded from any working capital adjustments. This ensures you walk away with the exact net cash you planned for in your exit strategy.