The 2017 Tax Act creates new opportunities for asset sales, particularly for sellers of businesses that are carried on in corporate form.

Whenever a business owned by a corporation is sold, the parties have to negotiate whether the transaction will be structured as an asset sale or a stock sale.

For tax purposes, asset sale treatment is generally more attractive to a buyer and may induce a buyer to pay a premium over what it would pay for a stock purchase.

Conversely, an asset sale will usually trigger higher tax expense to the seller.  Prior to the recent tax law change, the increase in tax expense was usually greater than the premium the buyer would pay, which meant that in practice corporate asset sales were disfavored.

However, starting in 2018, two significant changes became effective that altered this analysis.  First and foremost, the federal corporate tax rate was cut from 35% to 21%.  And the lower corporate tax rate was accompanied by a new regime that permits immediate expensing of tangible assets. Importantly, this regime also applies to used assets acquired from unrelated parties in certain types of asset transactions.

The following table compares the results to the seller of an asset sale versus a stock sale:

Stock Sale
$1,000,000 25%	Stock sale price Shareholder-level tax rate (all in)
$250,000	Shareholder-level stock sale tax
$750,000	Net to shareholder
Asset Sale
$1,200,000 $500,000	Asset sale price Asset tax basis
$700,000 25%	Corporate level-gain Corporate tax rate (all in)
$175,000	Corporate level-tax
$1,200,000 ($175,000)	Asset sale price Corporate level-tax
$1,025,000 25%	Cash available for dividend Shareholder-level tax rate (all in)
$256,250	Shareholder-level dividend tax
$768,750	Net to shareholder

The foregoing example incorporates a number of assumptions, including a 20% asset sale premium and results will vary depending on the specific facts.

That said, businesses with proportionately more assets that are tax-favored are the best candidates for asset sale treatment.  At the extremes, a business whose assets consist solely of tangible equipment and inventory will more likely benefit from an asset sale than a business whose assets consist solely of real estate or intangible assets.

CAVEATS

• This discussion focuses only on the tax treatment of a particular transaction. In fact, in some cases, a transaction can be structured as a stock sale for state law purposes and as an asset sale for tax purposes.  This is accomplished by making a special tax election.
• A corporation with significant tax loss carryforwards or high asset basis is more likely to benefit from an asset sale regardless of the specific mix of assets (and this was the case prior to the tax law changes).
• This discussion addresses the sale of a business that constitutes substantially all the assets of a corporation. If a corporation is selling off a minor division or a subsidiary that represents a small part of the total assets of the group, then it is often the case that the sale proceeds will be retained inside the corporation for reinvestment and not distributed to shareholders.  In that case, an asset sale is often more efficient than a stock sale.
• Our discussion is also limited to the case of a business carried on inside a regular or “C” corporation. Different considerations apply to a business carried on in an “S” corporation or in an entity taxed as a partnership.
• Finally, in recent months a significant trap for the unwary has arisen. As noted, in some case a transaction will be structured as a stock sale for state law purposes but as an asset sale for tax purposes.  This is accomplished by making a special tax election under either IRC Section 338 or 336.  As discussed above, a significant driver in favor of asset sale treatment is the expansion of immediate expensing to used assets.  To qualify for this deduction, however, the buyer and seller have to be unrelated for tax purposes.  Unfortunately, in certain fact patterns, an election under IRC Section 336 (but not under IRC Section 338) is treated as a sale between related parties.  Although many observers assumed that this legal fiction applied only for purposes of IRC Section 336, the IRS has announced that it also applies for purposes of the immediate expensing rule, with the result that certain transaction structured as asset sales will not provide the contemplated tax benefits if an election is made under IRC Section 336.  This could have a substantial effect on the economics of a deal.  Note that in this regard, Section 336 and 338 elections have different timing requirements.  Thus, if a buyer has an issue with the related-party rules and Section 336, then it may still be possible to file a timely Section 338 election for a transaction entered into in 2018.

For more information regarding tax structuring issues in the sale of a corporation, please contact Joseph Mandarino.