When You Sell a Business Are You Selling Your Entity?

When you sell a business are you selling your entity depends entirely on the deal structure the parties agree to. In a stock sale (or membership-interest sale for an LLC) you literally sell the legal entity itself, and the buyer steps into all of its assets, liabilities, contracts, EIN, and tax history. In an asset sale (used in roughly 60 to 70 percent of mid-market private deals per the ABA Private Target Mergers and Acquisitions Deal Points Study 2025) you keep the legal entity as a shell and sell only the specific assets and assumed liabilities the buyer wants.

Context: Why This Question Matters

Owners often discover at the LOI stage that the two-page term sheet quietly committed them to an asset sale, and they then spend the next 60 days realizing the tax bill is 15 to 25 percent higher than they assumed. The structure choice (stock versus asset, with the special case of a Section 338(h)(10) election sitting in between) drives the seller’s net after-tax proceeds more than almost any other variable except price itself.

It also drives what the seller is left holding the day after close. In a stock sale the seller walks away with cash and nothing else. In an asset sale the seller still owns the original corporation or LLC (now empty except for cash, any excluded assets, and any liabilities the buyer refused to assume), and has to either wind it down, hold it open for indemnity tail, or repurpose it. That post-close housekeeping is rarely discussed in the LOI and frequently surprises sellers.

The Detailed Answer

Stock sale: you are selling the entity. The buyer acquires 100 percent of the equity (stock of a corporation or membership interests of an LLC taxed as a partnership or corporation). Everything the entity owns or owes transfers automatically because the legal person did not change, only its ownership did. Contracts with customers, vendors, landlords, lenders, and franchisors typically do not require novation unless they contain a change-of-control clause. The EIN stays the same, payroll continues uninterrupted, bank accounts are simply re-titled to the buyer’s authorized signers, and litigation in progress stays with the entity. The ABA Private Target Deal Points Study 2025 reports that pure stock or equity-interest deals account for roughly 30 to 40 percent of mid-market private transactions, with the percentage rising sharply for S-corp targets eligible for a Section 338(h)(10) election.

Asset sale: you keep the entity. The buyer typically forms a new acquisition entity (NewCo) and that NewCo buys an itemized list of assets (FF and E, inventory, intellectual property, customer relationships, goodwill, assumed contracts, and working capital) plus assumes a defined list of liabilities (typically trade payables and the assumed-contract obligations going forward). Everything not on those two lists stays with the seller. The seller still owns the original LLC or corporation, which after close holds the cash proceeds and any excluded assets or liabilities. Most contracts must be assigned to the buyer, which usually requires written consent from the counterparty. The EIN does not transfer. The buyer obtains a new EIN, opens new bank accounts, runs new payroll, and may have to re-license depending on the industry. IRC Section 1060 governs how the purchase price is allocated across the asset classes, and the allocation drives the seller’s tax character class by class.

Tax consequences split sharply by entity type. A C-corp asset sale triggers two layers of tax: the C-corp pays corporate tax on the asset-level gain (21 percent federal plus state), and then the shareholders pay tax again when the after-tax proceeds are distributed (qualified dividend or capital gains rates plus 3.8 percent NIIT). The total effective rate can reach 40 to 45 percent. That double tax is the single biggest reason C-corp owners push hard for a stock sale, which produces only one layer of capital gains tax at the shareholder level. S-corp and partnership-LLC owners face one layer either way because the entity is a pass-through, but an asset sale still hurts: the IRC Section 1245 and 1250 recapture rules convert a portion of the gain on depreciated assets from long-term capital gain (20 percent federal) to ordinary income (up to 37 percent federal). Goodwill created internally is generally taxed at long-term capital gains rates, but allocated depreciable assets are not.

Buyer economics tilt the other way. Buyers strongly prefer asset sales for two reasons. First, they only inherit the liabilities they specifically agreed to assume, so any unknown skeleton (an undisclosed lawsuit, an unpaid sales tax exposure, an ex-employee discrimination claim, a CERCLA environmental issue) stays with the seller’s entity. Second, the buyer gets a step-up in tax basis equal to the purchase price allocated to each asset class, which means amortization deductions over 15 years for goodwill and customer relationships under IRC Section 197 and accelerated depreciation on equipment. On a $10M asset sale with $6M allocated to goodwill, the buyer recovers roughly $400K per year of basis through amortization for 15 years, worth $1M to $1.5M in present-value tax shield. That tax shield is real money and it is why buyers will pay more for an asset deal than a stock deal of the same headline price.

The negotiated concession runs 3 to 5 percent of purchase price. Because the buyer captures the basis step-up and avoids the inherited-liability risk, the buyer will often pay 3 to 5 percent more for an asset sale than a stock sale of the same target to bring the seller closer to whole on after-tax proceeds. M&A advisors model both structures during the LOI phase and use the comparative tax math to negotiate either the price or the structure. The AICPA M&A Tax Practice Guide treats this gross-up as a standard counterproposal when the buyer pushes for asset treatment.

The Section 338(h)(10) election bridges the gap. If the target is an S-corp (or a qualified subsidiary), the buyer and seller can jointly elect under IRC Section 338(h)(10) to treat the transaction as a stock sale for legal purposes but as an asset sale for federal tax purposes. The buyer gets the basis step-up. The seller gets the legal simplicity of a stock transfer (contracts move automatically, EIN stays, licenses transfer). The seller still faces the recapture-ordinary-income issue on depreciated assets, but the single layer of tax is preserved. The companion election under IRC Section 336(e) extends similar treatment to certain non-corporate buyers. These elections are filed jointly on IRS Form 8023 and are widely used in S-corp deals where the buyer is a corporation.

How to Decide: Five Factors That Drive the Structure

Factor 1: Entity type. A C-corp seller faces double tax on an asset sale, which usually pushes the deal toward a stock sale or a structure that avoids the second layer. An S-corp or LLC seller is indifferent on the double-tax issue but still has the recapture exposure on an asset sale. A sole proprietorship cannot do a stock sale at all because there is no entity to sell, only assets.

Factor 2: Buyer type. Strategic buyers (other operating companies in the same industry) often prefer asset deals to avoid inheriting historical exposures. Private equity buyers vary, but PE buyers acquiring S-corp platforms frequently push for Section 338(h)(10) elections. SBA-financed buyers (using the SBA 7(a) program) are usually required by the lender to do an asset sale because the SBA prefers a clean asset transfer and a new entity. Family transfers and management buyouts may go either way depending on the financing.

Factor 3: Transferability of licenses, contracts, and permits. If the business holds non-transferable licenses (a state medical license, a state liquor license, an FDIC bank charter, an SEC registered investment adviser license, a state contractor license that requires the named individual), the only way to keep continuity is a stock sale where the entity holding the license does not change ownership of the license, only of itself. The same logic applies to franchisor consents, long-term customer contracts with anti-assignment clauses, and government contracts under FAR Part 42.1204. If 80 percent of the business value sits in contracts that require counterparty consent to assign, an asset sale forces 80 percent of the value through a consent-collection exercise that can take 60 to 120 days and may give counterparties an opening to renegotiate terms.

Factor 4: Real estate. Owner-occupied real estate is almost always held in a separate LLC and sold (or leased back) separately from the operating business. That separation lets the seller do a 1031 like-kind exchange on the real estate, deferring capital gains, while the operating business sale closes in cash. If the real estate is inside the operating entity, the buyer almost always wants it carved out before the sale closes, and that carve-out itself is taxable unless structured carefully.

Factor 5: Known and unknown liabilities. If the company has any of the following, the buyer will almost certainly demand an asset sale: pending litigation, threatened claims from former employees, unresolved sales tax or payroll tax exposure, environmental contamination at a leased or owned site, product liability tail, or large unfunded pension obligations. The asset structure lets the buyer specifically exclude those liabilities. The seller then either retains them in the old entity or settles them out of sale proceeds before winding the entity down.

Worked Example: $10M Sale of an S-Corp HVAC Business

Assume a $10M sale of an S-corporation HVAC business owned 100 percent by a single founder. The business has $6M of internally generated goodwill, $2M of trucks and equipment with a depreciated tax basis of $400K, $1M of customer relationships, and $1M of working capital. The founder has held the stock for 12 years, so any equity gain qualifies for long-term capital gains treatment. The buyer is a private equity portfolio company.

The headline tax numbers look surprisingly close in this case because the seller’s basis in the equipment was already low (most of it had been depreciated out), and the bulk of the gain sits in goodwill at long-term capital gains rates either way. The real difference shows up when the buyer offers a structure-dependent price. Because the buyer values the basis step-up in the asset or 338(h)(10) case at roughly $1M to $1.5M of present-value tax shield, the buyer is typically willing to pay 3 percent more, or $300K, to get the step-up. That gross-up changes the math: $10.3M headline in an asset deal nets the seller roughly $7.47M, versus $7.12M in a $10M stock deal. The seller comes out $350K ahead by accepting the asset structure with the negotiated gross-up. Source for the gross-up convention: SRS Acquiom 2025 Deal Terms Study and AICPA M&A Tax Practice Guide.

What Most Owners Get Wrong

Misconception 1: “Stock sale always wins for the seller.” Not when the buyer prices it down. Sellers fixate on the headline structure without modeling the price differential. The right answer is to model both structures with the buyer’s likely price differential included, then pick the higher net-after-tax number. A 338(h)(10) is often the highest-net structure for an S-corp seller because it captures the buyer’s willingness to pay more while preserving single-layer tax treatment.

Misconception 2: “An asset sale means the buyer takes everything I own.” An asset sale means the buyer takes specifically listed assets and assumes specifically listed liabilities. Anything not listed stays with the seller’s entity. Sellers can and should exclude excess cash, personal items, certain receivables, and any liability not directly tied to ongoing operations. The schedule of excluded assets and liabilities is one of the most important negotiated documents in an asset deal.

Misconception 3: “If I sell the stock, I am completely walking away.” Not quite. Even in a stock sale, the seller typically signs a personal indemnity for breaches of representations and warranties, a non-compete (24 to 60 months), a non-solicit covering employees and customers, and often a transition services agreement requiring 30 to 90 days of post-close cooperation. The legal entity transfers, but the seller’s contractual obligations to the buyer continue for years.

How CT Acquisitions Approaches This

CT Acquisitions models both structures during the LOI phase with the seller’s tax advisor, then negotiates the structure-versus-price tradeoff as a single combined variable rather than two separate fights. We typically push for the structure with the highest net-after-tax proceeds to the seller after including any gross-up the buyer is willing to pay, which for S-corp sellers often points to a Section 338(h)(10) election.

We are buyer-paid, not seller-paid, which means our fee comes out of the buyer’s economics. The seller does not pay us a success fee out of the wire. That alignment lets us advocate for whatever structure actually maximizes the seller’s net, instead of optimizing for a percentage of a number that we benefit from inflating. Book a free consultation to model your structure before you sign the LOI.

Related Questions

What is the difference between stock sale and asset sale tax treatment?

A stock sale produces a single layer of long-term capital gains tax at the shareholder level (20 percent federal plus 3.8 percent NIIT plus state) on the difference between sale proceeds and the shareholder’s stock basis. An asset sale produces tax at the entity level (for C-corps) plus a second layer at the shareholder level when proceeds are distributed (the double-tax problem). For S-corps and partnerships there is no double tax, but the asset sale converts a portion of the gain on depreciated assets from long-term capital gain to ordinary income through Section 1245 and 1250 recapture, which can raise the effective rate by 10 to 15 percentage points on the recapture portion. See S-corp sale of business and 1031 exchange treatment for the S-corp-specific math.

Can I do a 1031 exchange on a business sale?

Not on the operating business itself. Section 1031 like-kind exchanges are available only for real property held for investment or business use as of the 2017 Tax Cuts and Jobs Act. The operating goodwill, equipment, and intangibles do not qualify. However, if the business owns real estate (the building, the land) inside the operating entity or in a separate holding LLC, that real estate can be sold separately and rolled into a 1031 replacement property to defer the real-estate gain. Most M&A advisors recommend bifurcating the real estate into a separate LLC well before sale to make this clean.

What happens to my EIN in a stock sale versus an asset sale?

In a stock sale the EIN does not change because the legal entity does not change, only its ownership does. Payroll, bank accounts, vendor records, and IRS filings continue uninterrupted under the same EIN. In an asset sale the buyer obtains a new EIN for the acquiring entity, opens new bank accounts, sets up new payroll, files a final Form 941 for the seller’s old EIN if the old entity is wound down, and re-applies for any required state licenses, sales tax permits, and unemployment insurance accounts.

Do I still owe the lawsuits and liabilities after a stock sale?

No, the entity does. In a stock sale the legal entity continues to own all of its liabilities including any pending or future lawsuits arising from pre-close conduct, but the seller personally is no longer the owner of that entity. The seller is liable to the buyer under the purchase agreement’s indemnification provisions (typically capped at 10 to 15 percent of purchase price for 12 to 24 months per the SRS Acquiom 2025 study), but is not directly liable to third-party claimants unless the seller personally guaranteed something or there is a fraud claim that pierces the corporate veil.

What is a Section 338(h)(10) election and when should I use it?

A Section 338(h)(10) election is a joint election filed by the buyer and seller on IRS Form 8023 that treats a stock purchase as an asset purchase for federal tax purposes only. The legal transaction remains a stock sale, so contracts, licenses, EIN, and bank accounts transfer automatically. The buyer gets the basis step-up and the seller faces asset-sale tax treatment (with the recapture issue) but only one layer of tax because the target is an S-corp. The election is available when the buyer is a corporation acquiring 80 percent or more of the stock of an S-corp or qualified subsidiary, and it is one of the most common structures in lower-middle-market S-corp deals where the seller wants stock-sale simplicity and the buyer wants asset-sale tax benefits.

What to Do Next

Before you sign an LOI, model both structures with your tax advisor and your M&A advisor side by side. The structure decision affects your net proceeds by 5 to 15 percent on a typical deal, which on a $10M sale is $500K to $1.5M of after-tax cash. That number is almost always larger than any other single negotiation point in the transaction.