Buying or selling a business is one of the largest financial transactions most business owners will ever complete. The tax treatment of that transaction — determined largely by how the deal is structured — can mean the difference of hundreds of thousands of dollars in after-tax proceeds for the seller, or years of additional depreciation deductions for the buyer.
Buyers and sellers almost always have opposing tax interests: buyers want asset purchases and fast depreciation; sellers want capital gains treatment and minimal ordinary income. Understanding both sides of this tension — and knowing how to negotiate a structure that works for both parties — is essential before any letter of intent is signed.
Asset Deals vs. Stock Deals: The Core Decision
Asset Purchase
In an asset purchase, the buyer acquires specific assets of the business (equipment, inventory, customer lists, goodwill, intellectual property, contracts) rather than the legal entity itself. The seller retains the legal entity, which is then dissolved or repurposed.
Buyer advantages:
- Steps up the tax basis in acquired assets to fair market value — enabling higher depreciation deductions going forward
- Avoids inheriting unknown liabilities of the selling entity
- Can cherry-pick which assets to acquire and which liabilities to assume
Seller disadvantages (C-Corp or S-Corp with built-in gains):
- Assets sold at gain above basis generate ordinary income or capital gain depending on asset type
- Depreciation recapture (Section 1245 for personal property, Section 1250 for real property) is taxed as ordinary income
- C-Corp sellers may face double taxation: corporate-level gain plus shareholder-level gain on liquidation
Seller advantages (pass-through entities):
- Gain flows directly to owner’s return; no entity-level tax
- Long-term capital gain treatment on assets held more than one year (excluding recapture)
Stock Purchase
In a stock purchase, the buyer acquires the equity (stock or membership interest) of the selling entity, which continues to exist with all its assets and liabilities intact.
Seller advantages:
- Single level of tax (no corporate-level gain for C-Corps if structured correctly)
- Typically results in long-term capital gain treatment on the sale of stock held more than one year
- Maximum capital gain rate of 20% (plus 3.8% Net Investment Income Tax for high earners) vs. 37% ordinary income rate
Buyer disadvantages:
- No step-up in asset basis — inherits the target’s historical tax basis in all assets
- Inherits all known and unknown liabilities of the entity
- Less depreciation deduction post-close
Section 338(h)(10) and Section 336(e) Elections
These elections allow a stock sale to be treated as an asset sale for tax purposes, providing the buyer with a step-up in basis while allowing the seller to receive stock sale treatment (in some cases). The 338(h)(10) election is available for S-Corp stock sales and certain subsidiary stock sales. It requires the consent of both buyer and seller and creates deemed asset sale treatment at the entity level.
This is a powerful planning tool when the tax gap between the buyer’s desired asset deal and the seller’s desired stock deal is significant.
Purchase Price Allocation: IRC Section 1060
When a business is acquired as an asset purchase (or treated as one under 338(h)(10)), the total purchase price must be allocated among seven asset classes under IRC Section 1060 and IRS regulations. Both buyer and seller must report this allocation on Form 8594 and file it with their tax returns.
The seven asset classes:
| Class | Assets included |
|---|---|
| Class I | Cash and cash equivalents |
| Class II | Certificates of deposit, U.S. government securities, foreign currency |
| Class III | Accounts receivable, mortgages, credit card receivables |
| Class IV | Inventory |
| Class V | All other assets (equipment, furniture, vehicles, real property) |
| Class VI | Section 197 intangibles (customer lists, covenants not to compete, licenses, franchises) |
| Class VII | Goodwill and going concern value |
Why allocation matters:
- Class V assets (equipment) generate ordinary income through depreciation recapture when sold; the buyer gets faster depreciation (5–7 year MACRS)
- Class VI assets (covenants not to compete) are amortized over 15 years by the buyer; the seller pays ordinary income rates
- Class VII goodwill generates long-term capital gain for the seller; the buyer amortizes over 15 years under Section 197
- Allocating more to goodwill is generally better for sellers; allocating more to equipment or covenants is generally better for buyers
Agreeing on allocation in the purchase agreement avoids disputes with the IRS and ensures both parties file consistent Form 8594s.
Earnouts and Seller Financing: Tax Treatment
Earnouts
An earnout is a contingent payment tied to post-close business performance (typically revenue or EBITDA over 1–3 years). From the seller’s perspective, earnout payments received after the initial close are generally treated as ordinary income if tied to employment, or as capital gain if tied to equity value — the distinction depends on how the earnout is structured and documented.
From the buyer’s perspective, earnout payments made are additional purchase price and may create additional amortizable goodwill or other basis depending on the asset classification.
Seller Financing (Installment Sales)
When the seller carries a note, the transaction qualifies as an installment sale under IRC Section 453. The seller recognizes gain proportionally as payments are received — spreading the tax liability over the installment period rather than recognizing it all in the year of sale.
The gross profit percentage (gain ÷ contract price) is applied to each payment received to determine the taxable portion. Interest on the note is taxable as ordinary income.
Installment sales are not available for sales of publicly traded stock or inventory.
Utah State Tax Considerations for Acquisitions
Utah Income Tax on Gain
Utah follows federal treatment of capital gains — long-term capital gains are taxed at Utah’s flat 4.65% income tax rate. There is no Utah-specific capital gains preference rate; all income, including capital gain, is taxed at 4.65%.
For Utah residents selling a business, the full gain (net of federal and Utah deductions) is subject to Utah tax. For non-residents selling a Utah-based business, Utah taxes the Utah-source portion of the gain.
Utah Sales Tax on Asset Transfers
Utah generally imposes sales tax on tangible personal property transferred in a business sale. However, the sale of a business as a going concern — where substantially all assets of a business are transferred together — may qualify for the occasional or isolated sale exemption from Utah sales tax. This exemption requires careful documentation and is fact-specific.
Equipment, vehicles, and inventory are most commonly subject to sales tax analysis in Utah business asset sales.
Utah Withholding on Sales by Non-Residents
If a non-Utah-resident seller has Utah-source gain from selling a Utah business, Utah may require the buyer to withhold Utah income tax from the payment and remit it to the Utah State Tax Commission.
Due Diligence: Tax Issues to Uncover Before Closing
As a buyer, tax due diligence should include:
- Federal and state tax returns: Review 3–5 years of returns. Look for audit history, large carry-forwards (NOLs, credits), aggressive positions, and inconsistencies.
- Payroll tax compliance: Confirm all Form 941s were filed and deposits made. Unpaid payroll taxes create trust fund liability that can follow the business and, in some cases, responsible individuals.
- Sales tax nexus and compliance: Determine whether the target has filed in all states where it has nexus. Unfiled sales tax returns are a common acquisition liability.
- Worker classification: Identify any independent contractors who may have been misclassified as employees. The buyer inherits the exposure.
- Section 481 adjustments: If the target is changing accounting methods post-close, there may be positive or negative Section 481 adjustments that affect the first year’s taxable income.
- Built-in gains tax (BIGs): For S-Corps that converted from C-Corps, any assets with unrealized gain at the time of conversion are subject to built-in gains tax at the corporate level if sold within 5 years of conversion.
Post-Acquisition Tax Integration
Step-Up and Depreciation Optimization
In an asset deal, work with your CPA immediately after close to:
- Complete Form 8594 with the agreed allocation
- Set up depreciation schedules for all acquired assets at their stepped-up values
- Identify any assets eligible for Section 179 expensing or bonus depreciation in the year of acquisition
- Establish amortization schedules for Section 197 intangibles (15-year straight-line)
Net Operating Loss Limitations
If acquiring a C-Corp with NOL carryforwards, Section 382 limits how much of those NOLs can be used after an ownership change. The annual limitation equals the value of the target’s equity multiplied by the long-term tax-exempt rate. Understand the Section 382 limit before pricing the value of inherited NOLs.
Combined Entity Tax Planning
Post-acquisition, review the combined entity’s tax position for opportunities: consolidated return filing, profit-shifting between entities, retirement plan consolidation, and changes to accounting method elections.
Engage Your CPA Before Signing the LOI
Tax structuring decisions in an acquisition cannot be changed after the deal closes. The letter of intent sets the frame; the purchase agreement locks it in. Engaging your CPA before the LOI is signed — not during due diligence and certainly not at closing — is the only way to protect your tax position.
Call (801) 927-1337 or visit cpaone.net/tax-planning to schedule an acquisition tax consultation. We advise both buyers and sellers on Utah business transactions, including purchase price allocation, installment sale planning, and post-close integration. You can also reach us by email at admin@cpaone.net.
Author Bio | Missy Dennis, CPA | Partner | FJ & Associates, PLLC | Kaysville, Utah | Missy holds a Master of Accounting degree from the University of Utah and is a licensed Certified Public Accountant. She is committed to providing clear, accurate, and actionable guidance so clients can navigate complex financial decisions with confidence. With more than twenty years of public accounting experience, Missy Dennis specializes in: Tax preparation and tax advisory; Bookkeeping strategy alignment; Estate and trust taxation; Audit and consulting services; Low-income housing tax credits; Non-profit accounting; Small- and mid-sized business advisory.
