Asset purchase stockholders' agreements.

• Author: Chamberlain, Steven M.
• Position: Tax Law

Astockholders' agreement is generally recommended whenever a closely held corporation has more than one stockholder. (1) Typically, a stockholders' agreement will restrict transfers of stock, protect an S election, and preclude competition and disclosures of information. In addition, control issues are often addressed via unanimous or super-majority voting requirements for all or selected actions (such as issuing new stock, selling assets, paying bonuses, etc.).

Stockholders' agreements almost invariably include a requirement for the surviving stockholder(s) or the corporation to purchase the stock held by the decedent's estate, with the price being established by a formula. If the obligation is funded with life insurance, the formula usually is a function of the face value of the policy. (2)

More comprehensive stockholder agreements include a "trigger offer" or "push-pull" procedure to enable a stockholder to "force a divorce." Under this procedure, any stockholder may make an offer at any time to buy the stock of another stockholder who then has, for example, 30 days to either 1) accept the offer and sell his or her stock at the offered price, or 2) match the price per share and buy the stock of the offeror(s). (3)

Reorganizations, estate planning, and asset protection issues are beyond the scope of this article. Rather, the focus of this article is on income tax planning, and for such purpose, it is assumed that the corporation has been an S corporation with two equal, unrelated stockholders since the business began more than 10 years ago. (4)

Income Tax Planning

Almost all stockholders' agreements call for a sale of stock at some point. If the purchase is by the corporation, the stockholders' agreement is said to use a redemption model. If the purchase is by the other stockholder, it is called a cross-purchase model. Although more complex, the cross purchase model is often considered advantageous from a tax perspective because, in comparison to the redemption model, the purchaser gets basis in the purchased stock. (5)

Many tax practitioners do not like the tax effects of a stock purchase and will recommend that the purchase price be set at an artificially low price and that each selling stockholder receive one or more termination bonuses under his or her employment agreement. Such an arrangement is common with professional corporations. Although such an arrangement generally increases each seller's income and employment tax liabilities, the remaining stockholder presumably is able to benefit from the passthrough of reasonable compensation deductions. The planning benefit is that the pattern of matching income and deductions is considered more tax efficient than the income tax consequences with a high stock price, which generally must be paid with after-tax dollars. For most tax practitioners, that is about the extent of income tax planning regarding stockholders' agreements.

Asset Purchase or Stock Purchase

It is generally understood that there are two principal ways to buy a business: a stock purchase or an asset purchase. The stock purchase is usually favored by the seller, but the buyer usually wants to purchase assets not only out of concerns regarding hidden liabilities or other historical problems at the corporate level, but also out of a desire to get the income tax benefits of purchasing assets instead of stock (discussed below). When part or all of the consideration for the asset purchase consists of a promissory note, the transaction is referred to as a leveraged buy-out, or LBO.

Capital Gain

If not related to the buyer, the seller of business assets is entitled to report capital gain.6 The major exceptions relate to 1) recapture of depreciation, 2) appreciated inventory, and 3) accounts receivable owned by cash-method taxpayers. Recapture of depreciation can be avoided via leasing selected assets to the buyer. In many cases, this is unnecessarily complex in that the buyer would get matching depreciation deductions. So instead of...