Page 238 - TaxAdviser_2022

TAX CLINIC

2008-18, but it ultimately requires a few Sec. 1222(3) has been met), which as soon as the purchase price allocations
additional steps to achieve the end goal. is currently subject to a favorable are finalized.
maximum tax rate of 20% (15% or 0% For example, incremental taxes can re-
Scenario 1: Stock purchase for taxpayers with taxable income below sult from ordinary and short-term capital
treatment certain thresholds). In addition, current gains on the sale of the underlying assets
If the buyer wishes to simply acquire law provides an exception from the of the business (e.g., Sec. 1245 recapture
stock and intends for the target to imposition of the net investment income on depreciable and amortizable assets,
remain an S corporation, the buyer will tax under Prop. Regs. Sec. 1.1411-7 appreciated inventory, appreciated real es-
need to get comfortable that the target’s for gains from dispositions of certain S tate, etc.) or from higher state taxes. State
S corporation status is valid, as it will corporation stock. tax liabilities can be higher in an asset sale
determine the tax classification and when compared with a stock sale due to
ultimately the entity type of the target Scenario 2: Asset purchase the potential for a higher income tax base
in the buyer’s hands. Therefore, due dili- treatment and depending on where the business (as
gence should be performed concerning Buyers generally prefer to acquire assets, opposed to the shareholder) is liable for
documentation of the S status. as they will receive a stepped-up basis in state taxes.
The buyer should note that tax attri- the target’s underlying assets, and any risk Another consideration in an asset sale
butes are generally unaffected by a stock associated with acquiring the stock of the is the potential imposition of built-in
transfer, as the attributes belong to the business (e.g., the validity of the S status, gains (BIG) tax under Sec. 1374 in addi-
corporation and are generally transferred undisclosed claims/liabilities) is poten- tion to shareholder-level taxes. The BIG
to the buyer together with the other cor- tially mitigated. However, if the seller tax generally applies to C corporations
porate assets. However, limitations may insists that the stock be legally sold, a that make an S election and have unreal-
apply with respect to the buyer’s ability Sec. 338(h)(10) or 336(e) election can be ized built-in gains on the conversion date
to use certain acquired tax attributes made. Such elections result in a deemed and to tax-free acquisitions of C corpo-
following the ownership change. The tax asset sale for both buyer and seller, thus ration assets by an S corporation. The
basis of the S corporation’s underlying creating income tax results similar to an target entity could be liable for BIG tax
assets and the S corporation’s tax ac- actual asset sale. if certain assets that existed at the time
counting methods are also not affected Depending on the nature and value of of the conversion or acquisition are sold
by the stock transfer — asset basis and the target’s underlying assets, an asset sale during the statutory recognition period.
accounting methods carry over to the could produce favorable tax deductions The BIG tax is computed by applying
new ownership. for the buyer — such as, but not limited the highest corporate tax rate (currently
Additionally, a buyer of stock to, accelerated depreciation under Sec. 21%) to the net recognized built-in gain
could potentially inherit the target 168(k) for eligible fixed assets and amor- for the tax year, creating incremental taxes
company’s undisclosed liabilities for tization of intangible assets including for the seller.
taxes attributable to prior C corporation goodwill under Sec. 197. Buyers and sellers should carefully
periods and potential state and local While asset sale treatment can signifi- review whether proper, complete docu-
income taxes. Many states do not cantly benefit the buyer from an income mentation has been maintained and is
follow federal rules for taxation of S tax perspective, it can negatively impact available with respect to the underlying
corporations, and some that do also the seller by potentially increasing the assets of the corporation as of the S elec-
impose entity-level taxes, in addition seller’s overall tax burden on the sale of tion effective date. Such documentation
to flowthrough tax treatment for the business as compared with Scenario includes, but is not limited to, asset ap-
shareholders (e.g., California and 1. Accordingly, most sellers request a praisals, tax basis records and calculations,
Illinois). If the target was never gross-up be factored into the purchase and documentation of tax attributes from
a C corporation, the risk of prior price negotiations before committing or the period that the corporation was a C
federal taxes is moot, but the state agreeing to an asset purchase arrange- corporation, which ultimately can affect
nexus profile of the target should be ment. A gross-up generally provides any potential BIG tax.
carefully reviewed. additional proceeds to the seller intended
From the seller’s perspective, a stock to make the seller whole with respect to Scenario 3: F reorganization
sale is often desired, as it results in any incremental taxes owed on the asset approach
one level of tax, with the gain being sale as compared with a hypothetical The steps necessary to execute a proper
long-term capital gain (assuming the stock sale. In a typical gross-up arrange- F reorganization under Sec. 368(a)(1)
holding period requirement under ment, a gross-up calculation is performed (F) are included in Rev. Rul. 2008-18.

20 May 2022 The Tax Adviser