The buyer wants to structure our acquisition as an asset purchase to maximize their tax basis depreciation under Section 197, but our corporate structure makes an asset sale far more expensive for us than a stock sale. How do we calculate and negotiate a tax gross-up payment to offset the extra tax burden of an asset deal?

Question

Tyler Smith · Accepted Answer

Corporate buyers prefer asset purchases because they can step up the tax basis of your acquired tangible and intangible assets, amortizing goodwill over 15 years under Section 197. For owners of C corporations, or S corporations with built-in gains and significant ordinary income recapture, an asset deal creates severe double taxation or shifts capital gains into higher ordinary income brackets.

You should never subsidize the buyer's future tax deductions by quietly absorbing a larger tax bill today.

Start by commissioning your tax advisor to model two distinct net proceeds schedules:

- Schedule A: A pure stock sale, showing total net cash proceeds after standard federal and state long-term capital gains taxes.
- Schedule B: An asset purchase, showing the tax drag from ordinary income recapture on depreciation, state tax differentials, and unamortized intangibles.

The dollar difference between Schedule A and Schedule B is your net tax differential. To make you whole, the buyer must pay a tax gross-up. You cannot simply add that exact differential to the purchase price, because the gross-up payment itself will be taxed. You must gross up the gross-up using the effective blended tax rate applicable to that incremental income.

When presenting this to the buyer, remind them that their Section 197 tax shield creates substantial net present value for them. Calculate the present value of the buyer's future tax savings generated by the basis step-up.

If their tax shield generates two million dollars in net present value, and your tax gross-up requirement is eight hundred thousand dollars, the buyer still comes out comfortably ahead. Make the math transparent. If they refuse to fund the gross-up, revert the transaction structure to a straight stock purchase.