Comparing stock sales and asset sales of S corporations.

• Author: Markwood, Linda

This case study has been adapted from PPC's Tax Planning Guide: S Corporations, 35th edition (March 2021), by Andrew R. Biebl, Gregory B. McKeen, and George M. Carefoot. Published by Thomson Reuters, Carrollton, Texas, 2021 (800-431-9025; tax.thomsonreuters.com).

The seller of an incorporated business generally prefers to dispose of stock, while the buyer prefers to purchase the assets directly from the corporation. From the buyer's perspective, the acquisition of assets allows a fresh tax basis for depreciation purposes and also generally eliminates the buyer's responsibility for claims and other actions against the corporation arising before the purchase. From the seller's viewpoint, stock sales are attractive because of eligibility for installment reporting of gain on the disposition and potential benefits from reporting the entire gain as a capital gain, as opposed to reporting depreciation and other recapture items as ordinary income, which would occur upon a sale of assets.

While the issue of stock sale versus asset sale generally is more critical for a C corporation than for an S corporation (because of the probability of double taxation facing a C corporation and its shareholders upon sale and liquidation), there are still a number of significant issues to be considered by S shareholders.

Making installment sales

The availability of the installment method of reporting is an attractive element associated with the sale of S corporation stock. However, a special rule eliminates the tax advantage of installment reporting on the sale of stock if the sale price exceeds $150,000 and the year-end installment receivables balance from all installment sales (for more than $150,000) arising during the tax year exceeds $5 million. Interest on the tax deferral must be paid to the IRS in the year of sale and succeeding years until all installment receivables arising during the year are collected (Sec. 453A). If assets are sold directly by the S corporation, the installment method of reporting is not allowed for gains associated with inventory, depreciation recapture, and other ordinary income items (Sees. 453(b)(2) and 1245(a)(1)).

Another concern with installment sales occurs if the stock is sold to a "related person" whose stock would be attributed under Sec. 318(a) (other than attribution by stock option) or Sec. 267(b). Sec. 453(e) states that if the related person sells the stock within two years, all or part of the initial seller's deferred...