Asset Sale or Stock Sale? The Double Tax on a C Corporation: the facts

1. A C corporation that sells its assets pays the 21% corporate rate on the gain over its basis in them (§§ 1001, 11(b)). When it then distributes what is left in liquidation, the shareholder pays the gains rate on the distribution over the stock basis (§ 331). That is the double tax.
2. A shareholder who sells the stock pays once, at the gains rate on the price over the stock basis. The corporation's assets keep their old basis in the buyer's hands, so the buyer gets no fresh depreciation from the price paid (§ 1012 applies to the stock, not the assets).
3. Example: a corporation sold for $5,000,000 with $1,000,000 of basis in its assets and $500,000 of stock basis, at 20% plus the surtax: an asset sale leaves $3,288,920 after $840,000 of corporate tax and $871,080 at the shareholder level; a stock sale leaves $3,929,000. The double tax costs $640,080.
4. To leave the seller where a stock sale would, an asset buyer would have to pay $6,063,291 in the example, a gross-up of $1,063,291. That gap is what the buyer's stepped-up basis is worth in the negotiation.
5. An S corporation or a subsidiary can be sold as stock with a joint election to treat the deal as an asset sale for tax (§ 338(h)(10); § 336(e)), giving the buyer the step-up with one level of tax. A C corporation with outside shareholders cannot: for it, the choice is real.
6. The 3.8% surtax reaches the gain on C corporation stock and on a liquidating distribution whether or not the shareholder worked in the business (§ 1411(c)(1)(A)(iii) excepts only assets of a trade or business the taxpayer runs, and stock is not one). Qualified small business stock held five years may be excluded instead (§ 1202).

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