We operate as an S corporation, and the buyer is insisting on an asset sale under Section 338h10 to get a tax step-up in basis, but this will trigger a higher tax rate for us on ordinary income recapture. How do we calculate this tax friction and structure a gross-up clause to make ourselves whole?

Question

Tyler Smith · Accepted Answer

When a buyer requests an asset sale or a Section 338h10 election, they are looking to step up the tax basis of your assets so they can claim higher depreciation and amortization deductions post-close. While this is great for their cash flow, it creates massive tax friction for you as an S corporation owner.

In a stock sale, almost all your gains are taxed at favorable long-term capital gains rates. In an asset sale, your gains are split. Any gain allocated to equipment, inventory, and accounts receivable is subject to depreciation recapture and taxed at higher ordinary income rates, which can easily reduce your net walk-away cash by ten to fifteen percent.

To protect your proceeds, you must negotiate a tax gross-up clause. This clause requires the buyer to increase the purchase price by the exact amount of the incremental tax liability you incur by agreeing to their preferred structure.

To execute this, have your CPA run a detailed tax allocation model immediately. This model must compare a hypothetical stock sale against the proposed asset sale to determine the exact tax delta. Present this calculation to the buyer as a non-negotiable deal term. If they want the asset write-off, they must pay for it.

Keep your leadership team focused on executing their Rocks and hitting your quarterly targets so your performance remains strong while you resolve these structural negotiations. Do not let tax technicalities distract you from running your business with a disciplined operational rhythm. Use your V/TO® to stay aligned on the big-picture numbers.