Asset sale, stock sale, or F-reorganization: which one your deal really is

Why the buyer and the seller start on opposite sides

Nearly every fight over deal structure comes down to one word: basis. Basis is what the tax code treats as your cost in something, and it decides who gets to write off the price. In an asset purchase, the buyer treats the money it pays as the new cost of the things it bought, so it can deduct goodwill and other intangibles over 15 years and expense much of the equipment right away. In a stock purchase, the buyer steps into your shoes and inherits your old basis, which for a business you built rather than bought is usually very low, so the buyer gets almost nothing to write off.

That difference is worth a large amount of money to a private equity buyer, so they start every negotiation wanting an asset purchase, or something that is treated like one for tax. You, on the other side, usually want capital gain treatment and, if you are rolling equity, you want to avoid paying tax on the part you did not receive in cash. The structures below are the ways deals reconcile those two wishes. Which one fits you depends mostly on whether your company is an S corporation, an LLC, or a C corporation.

The plain asset sale, and its double-tax problem for C corporations

In a straight asset sale the company sells its assets and the buyer walks away with them. For an S corporation or an LLC this is a single level of tax: the gain passes through to you once. The awkward part is mechanical rather than tax. Contracts, licenses, and permits often have to be reassigned one at a time, sometimes needing the other side's consent, which slows a deal and can spook a key customer.

For a C corporation the asset sale carries a real tax cost. The company pays 21 percent corporate tax on the gain, and then you pay again when the after-tax cash comes out to you, a combined federal rate approaching 40 percent before any state tax. That double tax is the reason a C-corporation owner often wants to sell stock instead, and it is why tools like personal goodwill and QSBS matter so much for those owners.

The plain stock sale, and why private equity resists it

In a stock sale you sell your shares and the buyer takes the company as it is, contracts and all. For you this is clean: one level of tax, capital gain on the whole thing, no reassigning of agreements. The problem is the buyer. A stock purchase gives them carryover basis and no step-up, so they lose the 15 years of write-offs that an asset deal would have produced. Private equity buyers rarely accept that, and when they do buy stock they usually insist on an election that lets them treat the purchase as an asset deal for tax while still buying the shares for legal purposes. Those elections are 338(h)(10) and 336(e), described below.

There is one important exception. If you hold C-corporation stock that qualifies as QSBS, a stock sale can exclude a large amount of the gain from federal tax, which can outweigh everything the buyer would pay for a step-up. In that case the seller wants a stock sale badly, and the structure becomes a price negotiation rather than a tax formality.

The F-reorganization, the standard answer for an S corporation

Most owner-run businesses under $20 million are S corporations, and for them the private equity playbook is the F-reorganization, named for Section 368(a)(1)(F) of the tax code and blessed for this use by Revenue Ruling 2008-18. It sounds elaborate, but the point is simple: give the buyer asset treatment while letting you defer the rollover. Here is the sequence.

1. Form a holding company and contribute your stock

   You create a new corporation, the holding company, and contribute all of your operating company's stock to it. You now own the holding company, and the holding company owns your original business.

2. Elect to treat the operating company as a disregarded subsidiary

   The holding company files Form 8869 to treat your operating company as a qualified subchapter S subsidiary, a QSub, which the tax code ignores as a separate entity. Your S election effectively moves up to the holding company.

3. Convert the operating company to an LLC

   Your operating company converts under state law into a single-member LLC owned by the holding company. Because a single-member LLC is disregarded for tax, nothing taxable happens, and the company keeps its employer ID number and its contracts.

4. The buyer purchases LLC interests

   The buyer buys most of the LLC interests from the holding company, and you roll the rest. Under Revenue Ruling 99-5, the buyer is treated as buying a share of the assets directly, which gives them the step-up they wanted, while the interests you keep ride along as a deferred rollover.

The result is that the buyer gets asset treatment, you get capital gain on the cash and tax deferral on the rolled equity, and the operating business never legally changes hands, so it keeps its tax ID, its licenses where they attach to the entity, and its customer and vendor contracts. That last point saves weeks of consents and is a quiet reason the structure is so common.

338(h)(10) and 336(e), and why they tax your rollover

Before the F-reorganization became routine, the usual way to get asset treatment on a stock deal was a joint election under Section 338(h)(10), filed on Form 8023. It treats a stock purchase as a deemed asset sale, so the buyer gets the step-up. Section 336(e) does something similar and, unlike 338(h)(10), does not require the buyer to be a corporation.

The catch is in the word deemed. Because the whole sale is treated as an asset sale, 100 percent of the gain is taxed now, including the portion you rolled into the buyer's company and never received in cash. You can owe tax on equity you cannot spend. A 338(h)(10) election also requires the buyer to acquire at least 80 percent and to be a corporation, and it depends on your S election having been valid the whole time, which diligence sometimes calls into question. The F-reorganization avoids all of that: no 80 percent floor, the buyer need not be a corporation, the rollover defers, and the deal does not hinge on a clean S-election history. That is why deals with a meaningful rollover moved toward the F-reorganization and left these elections for the cases where there is little or no rollover.

The built-in gains trap for a young S election

One issue rides underneath all of these structures and the F-reorganization does not fix it. If your company was a C corporation and converted to an S corporation less than five years before the sale, Section 1374 can tax the gain that was built up during the C years, most often the goodwill, at 21 percent at the company level in the year of sale, before that gain passes through and is taxed again to you. The F-reorganization neither creates this recognition period nor cures it; it simply carries whatever exposure you already have. If your S election is recent, ask your CPA to measure the built-in gain before you sign, because it can change the after-tax math substantially.

The seller's-eye comparison

How the price is divided within any of these, and therefore how much is capital gain versus ordinary income, is set by the allocation under Section 1060 and reported on Form 8594. The how a sale is taxed page walks through that split, and the earnouts and installment sales page covers what happens when part of the price is paid over time.

When the structure choice does not matter much to you

The structure is a large lever in some deals and almost irrelevant in others. If you run an S corporation or LLC and there is no rollover, an asset sale and an F-reorganization land in nearly the same place for you, and the choice is the buyer's to make for their own reasons. If your whole price is goodwill, you live in a no-tax state, and you are taking all cash, the capital gain result is already there and the fine print of the structure changes little. The structure matters most when there is a meaningful rollover to defer, when your S election is young enough to trigger built-in gains tax, or when you hold C-corporation stock where a plain stock sale plus QSBS beats everything else.

What to do next

Find out three things before you respond to a letter of intent. First, your entity type and, if you are an S corporation, the exact date of the election, so you can measure any built-in gains exposure. Second, whether the buyer is proposing an F-reorganization, an outright asset sale, or a stock deal with an election, because that decides how your rollover is taxed. Third, if you are a C corporation, whether your stock could be QSBS, which can flip the entire analysis toward a stock sale. Bring those answers to your CPA and deal counsel, model the result in the after-tax proceeds calculator, and if you want a second set of eyes on how the structure interacts with your rollover and your life after the sale, that is what a first conversation is for.