The buyer is insisting on an asset purchase agreement to get a tax step-up in basis, which will trigger massive depreciation recapture taxes for our S-corporation. How do we structure a tax-equalization payment to make sure we net the same cash as a stock sale?

Question

Tyler Smith · Accepted Answer

When a buyer demands an asset sale, they are looking out for their own tax health. The asset purchase allows them to step up the tax basis of your physical and intangible assets, creating huge depreciation deductions for them post-close. For you, however, an asset sale can trigger depreciation recapture and ordinary income taxes that severely erode your net proceeds compared to a stock sale.

To protect your net cash, you must demand a tax-equalization clause in the letter of intent. This clause requires the buyer to pay a premium, often called a gross-up, to cover the incremental tax liability you incur by agreeing to an asset sale.

To execute this, have your CPA run parallel tax models comparing a straight stock sale with the proposed asset sale. Calculate the exact dollar difference in your net after-tax proceeds, factoring in state and federal rates, depreciation recapture, and ordinary income treatment.

Present this calculation to the buyer as a non-negotiable adjustment to the purchase price. If they want the tax benefits of an asset step-up, they must pay for them. If they refuse, suggest a compromise under Section 338(h)(10) or a joint election where the transaction is treated as an asset sale for tax purposes but structured as a stock sale for legal purposes, with the buyer paying the required gross-up to keep you whole.