How a business acquisition is structured has a direct and significant impact on the tax outcomes for both the buyer and the seller. Understanding the key tax implications early, before terms are finalized, can protect deal value and prevent costly surprises at closing.
Asset Sale vs. Stock Sale
This is the most consequential tax decision in most acquisitions. Buyers typically prefer asset sales because they can step up the tax basis of acquired assets to fair market value, allowing for higher depreciation deductions and better post-acquisition cash flow. Sellers generally prefer stock sales because proceeds are taxed at the lower long-term capital gains rate rather than ordinary income rates. This tension is common in negotiations, and purchase price adjustments or other deal terms are often used to bridge the gap.
How Entity Type Affects the Deal
The tax classification of the target business matters significantly. C-Corporations are subject to double taxation. The entity pays tax on any gain, and shareholders pay tax again on proceeds received. S-Corporations and pass-through LLCs avoid this, with gains taxed once at the owner level. For S-Corp acquisitions, a Section 338(h)(10) election allows both parties to treat a stock sale as an asset sale for tax purposes, giving the buyer a stepped-up basis while the seller retains stock sale treatment. This is a valuable tool worth exploring in the right situation.
Purchase Price Allocation
In an asset acquisition, the IRS requires both parties to allocate the total purchase price across acquired asset categories under Section 1060. Buyers prefer allocating value to short-lived depreciable assets that can be written off quickly. Sellers often prefer allocating more to goodwill, which is taxed at capital gains rates. Because the IRS requires consistent reporting from both parties, this allocation is an important negotiating point that deserves attention before the deal is signed.
Tax Due Diligence
Before closing, buyers should conduct thorough tax due diligence. Buyers can do this by reviewing federal and state tax returns, identifying outstanding audits or disputes, confirming sales and use tax compliance, and assessing deferred tax liabilities. In a stock acquisition, the buyer inherits the target’s entire tax history, making this step especially critical. State tax exposure has grown considerably since the Wayfair decision expanded nexus rules, and undisclosed multistate liabilities can represent meaningful deal risk.
Installment Sales, Earnouts, and Transaction Costs
Installment sales allow sellers to spread taxable gain over multiple years, potentially reducing their overall tax burden, though buyer default risk and ordinary income treatment on interest must be considered. Earnouts can be taxed as capital gains or ordinary income depending on how they are structured, so the language matters. On the cost side, most buyer transaction fees must be capitalized rather than deducted immediately, while sellers can generally apply these costs to reduce taxable gain.
To Summarize
Tax planning in an acquisition should begin at the negotiating table, not after the buyer signs the deal. The structure, allocation, and timing of a transaction all carry tax consequences that frequently affect the economics on both sides. Working with an experienced M&A advisor alongside a qualified tax professional helps ensure the deal is structured to achieve your goals while minimizing unnecessary exposure. If you are considering buying or selling a business, contact the team at First Midwest Advisors to get started.
Jason Sanders | Managing Partner
517 206 7464