Key Tax Considerations When Selling Your C Corporation
Selling a closely held C corporation is a momentous event for founders and shareholders who have devoted their time and resources to growing the business. However, the stakes are high: tax consequences, future liabilities, and maximizing value all come into play.
For owners and management of closely held C corporations, deciding to sell the business isn’t a simple matter of finding a willing buyer and closing the deal. The push and pull between asset and stock sales entails critical tax, legal, and practical considerations.
Key among these are:
- The buyer’s eagerness to acquire a basis step-up.
- The seller’s drive to reduce double taxation.
- The possibility of using Net Operating Losses (NOLs) and other attributes to reach a mutually beneficial compromise.
- Section 382/383 limitations that might curtail the use of carryforwards post-transaction.
- The inheritance of tax liabilities in a stock acquisition.
Proactive planning, detailed modeling, and thoughtful negotiation strategies can transform these hurdles into opportunities. By engaging experienced tax advisors, understanding the interplay of deal structures, and preparing robust financial models to show after-tax outcomes, sellers can ensure they increase their after-tax return on the sale while giving buyers a compelling reason to offer competitive terms.
Gain insights into these key considerations for C corporation sellers and their management teams that can help you come to the negotiation table in a strong position.
Leveraging NOLs and Other Tax Attributes
In many closely held C corporations, the business might have experienced periodic losses or made specific investments resulting in NOL carryforwards or other tax attributes, such as tax credits. Although these losses may not have been ideal from a historical business perspective, they can provide significant tax-planning opportunities during an M&A event.
Shielding Gain in an Asset Sale
If a C corporation has substantial NOL carryforwards, it may be able to use them to offset all or part of the gain recognized upon selling assets.
From the buyer’s perspective, this opens the door to an asset sale that might not trigger a meaningful—or any—corporate-level tax, effectively reducing the tax burden.
The seller then gains leverage by allowing the buyer to enjoy a full basis step-up without incurring a heavy corporate tax. In return, the seller can negotiate a higher purchase price or other favorable terms to compensate for agreeing to the structure granting the buyer that step-up. The seller must evaluate whether any NOL carryforwards are subject to limitations under Section 382 as a result of a prior ownership change—as discussed below, which could restrict their ability to offset gain.
Modeling in Advance
The key to capitalizing on these benefits is advanced modeling. Evaluate different sale structures—stock versus asset—and measure the after-tax outcomes, including the potential cash flow benefits that potential buyers would receive in an asset deal.
With solid analytics in hand, sellers can enter negotiations armed with actionable insights, ready to propose or counter proposals in a way that helps them meet their after-tax cash objectives.
Sections 382 and 383: Using NOLs in a Stock Deal
If the buyer decides to acquire the stock of the corporation rather than its assets, the buyer assumes the corporation’s existing tax attributes—like NOLs and credits—subject to specific limitations in the Internal Revenue Code, notably Sections 382 and 383. These provisions generally limit the number of pre-existing losses and credits that can be used after a more-than-50% ownership change in the corporation.
Overly simplistic assumptions about the availability of losses can derail the buyer’s assumptions on post-deal tax benefits. For example, historic capital raises, convertible instruments, and prior changes in ownership can complicate the usage of these tax attributes.
Implications for Sellers
Sellers should be prepared for potential buyer due diligence into NOL utilization and track records of capital infusions or share ownership changes.
If there have been substantial ownership changes or equity shifts in the past, the Section 382 limitation on NOL usage might be more restrictive than expected.
Having this analysis done in advance—ideally with the assistance of tax advisors—enhances credibility and helps avoid last-minute renegotiations of deal value or structure.
Assessing and Cleaning Up Historic Tax Exposures
When a buyer acquires stock, they also inherit the historic liabilities of the target corporation. including:
- Federal and state income tax liabilities.
- Sales and use tax liabilities.
- Payroll, property, and other non-income taxes.
Why This Matters
Buyers will conduct thorough tax diligence to understand the potential exposure for back taxes, penalties, or ongoing disputes. Sellers should proactively clean up compliance deficiencies, address unresolved audits, and ensure that any outstanding liabilities are disclosed and reserved for, if necessary.
Establishing that the corporation’s tax compliance history is in good standing—or at least well-documented and mitigated—can protect transaction value and reduce last-minute surprises that might dampen buyer interest or reduce the purchase price.
Practical Tips for Sellers
Selling a business is a complex process. Position your transaction for success with the following practical tips.
- Engage Advisors Early. Tax structuring opportunities rarely succeed when discovered too late. Work with tax professionals well ahead of a potential sale to chart multiple scenarios and understand possible pitfalls.
- Quantify the Value of a Step-Up. If your corporation has NOLs or other offsets, quantify the likely tax shield an asset sale would generate for the buyer. This analysis can be translated into actual dollar terms to support the case that the buyer should pay more, or grant other concessions, for the privilege of acquiring assets with a step-up.
- Document Past Ownership Changes. Keep detailed records of all equity transactions, including partial sales, gifts, investments, and conversions, to accurately assess Section 382 limitations.
- Manage Liabilities and Compliance. Perform—or hire professionals for—a tax health check of the corporation. Address any outstanding issues to avoid diminishing the value of a stock sale or frightening off potential buyers.
We’re Here to Help
To learn more about key tax considerations associated with selling C corporations and how they can benefit your business transaction, contact your Moss Adams professional.