Selling an S-Corp: Asset Sale vs. Stock Sale

#Why buyers and sellers start every deal in different corners

Every S-corp exit starts the same way. Your lawyer and the buyer’s lawyer sit down at the letter-of-intent stage. They each want a different deal structure. This is not stubbornness. It is economics.

#The buyer’s case for an asset sale

Buyers want an asset purchase. When a buyer buys a business’s assets, they get to “step up” the tax basis of every asset. The new basis is the purchase price. That means the buyer can depreciate equipment at the new higher value. They can amortize goodwill and intangibles over 15 years under IRC §197. They may also speed up deductions through bonus depreciation under §168(k). Say a deal has $4M of goodwill and intangibles. A buyer with a 21% corporate rate captures about $840,000 of future tax savings from the step-up alone. That is real money. It affects what they are willing to pay.

An asset purchase also gives the buyer a clean break from your history. Unknown tax exposures, pending lawsuits, old audit risk, and undisclosed bills all stay with your legal entity. They do not pass to the buyer. For buyers, the logic is simple: pay for what you want, leave behind what you do not.

#The seller’s case for a stock sale

You want a stock sale. Your S-corp shares are capital assets under IRC §1221. When you sell, the whole gain is taxed once at long-term capital gain rates (0%, 15%, or 20% federal, depending on your income). If you work in the business, NIIT often does not apply to the sale of your S-corp stock. If you do not work in it, the 3.8% Net Investment Income Tax (NIIT) can apply once your income passes the threshold. One level of tax. Capital gain character. A clean exit.

An asset sale is far messier for you. The S-corp sells its assets. The gain flows through on your Schedule K-1. The character of the gain depends on what you sold. Did you sell accounts receivable and inventory? That is ordinary income, taxed at up to 37% federal. Some of that may qualify for the 20% QBI deduction. Your tax on that part could be lower than 37% (limits apply). Did you sell equipment with years of depreciation on it? §1245 recapture turns those old deductions back into ordinary income. Only goodwill and going concern produce capital gain. You end up with a mix of ordinary and capital income on the same exit. You pay more overall.

#The dollar gap on a real deal

This gap is not theoretical. Picture a $5M exit with $500K of net asset tax basis. Say $2M of the gain is ordinary income (from recapture and receivables) and $2.5M is capital gain:

• Asset sale federal tax: roughly $740K ordinary income tax + $595K capital gains tax = $1.335M total
• Stock sale federal tax: $4.5M all at capital gain rates = roughly $1.071M total
• Difference: $264K more in your pocket from a stock sale, before state taxes

That gap is why every deal involves a structural negotiation, and why the §338(h)(10) election was created.

#The asset sale: what it costs you as the seller

In a straight asset sale, the S-corp sells each category of asset on its own. Tax character depends on the asset class.

#Ordinary income assets

• Accounts receivable that arose in the ordinary course of business: ordinary income
• Inventory held primarily for sale to customers: ordinary income
• Equipment and machinery with accumulated depreciation: §1245 recapture turns prior deductions back into ordinary income, up to the amount you already claimed

These categories often make up a large share of deal value for service businesses and product companies. Say your business has $1M of accounts receivable and $500K of depreciated equipment. That is $1.5M of ordinary income right there, before any goodwill.

#Capital gain assets

• Goodwill (Class VII in Form 8594 allocation): long-term capital gain, taxed at preferential rates
• Going concern value: long-term capital gain
• Customer lists and certain §197 intangibles held more than one year: generally capital gain, though specific facts can shift some to ordinary income

#When sellers accept asset sales anyway

Asset sales do happen, and sometimes they are the right call. They tend to work when:

• The business has few depreciable assets and most value is in goodwill (software companies, consultancies)
• The buyer offers a price premium of 5 to 15% to make up for the seller’s tax inefficiency
• The seller’s basis in S-corp stock is already close to the purchase price, so the ordinary vs. capital split matters less on a small overall gain

Know your number before you sit down at the table.

#The stock sale: why you prefer it and what the buyer risks

In a stock sale, you sell your S-corp shares straight to the buyer. The buyer steps into your shoes as the S-corp’s shareholder.

#What you get as the seller

Your gain is long-term capital gain, as long as you have held the shares more than one year. The ordinary vs. capital question disappears. Federal rates top out at 20% plus 3.8% NIIT for high earners. The whole deal is simpler to report and model.

One thing to track carefully: your outside basis in the S-corp shares sets the total gain on the sale. Say you have run the S-corp for years with retained earnings, allocated losses, or contributed property. Your basis may differ a lot from your original investment. Calculate it correctly before you agree to a sale price. If you are not sure where your basis stands, read our guide to S-corp shareholder basis tracking before you get to the closing table.

One more item worth checking: your S-corp may qualify as a qualified small business corporation (QSBC). If so, gain on a stock sale may partly or fully qualify for the §1202 exclusion. The gain exclusion depends on when you got the stock. Stock acquired after July 4, 2025 can exclude up to $15 million. It excludes 50% after 3 years, 75% after 4, and 100% after 5. Older stock follows the $10 million, 5-year rule. Section 1202 needs the company to be a C corporation for substantially all of the time you hold the stock. Years as an S corporation count against that. So stock in a company that switched to S status rarely qualifies. Ask a tax pro before you count on it. See QSBS and the §1202 exclusion for the details.

#What the buyer inherits and why they push back

The buyer buys the stock and now owns the S-corp as-is:

• Carryover tax basis in all underlying assets, no step-up anywhere
• Historical tax liabilities and any open prior-year audit periods
• Unknown or contingent liabilities that may surface months after close
• Potential built-in gains tax exposure if the S-corp previously converted from a C-corp

Most sophisticated buyers want protection before they accept a pure stock deal: heavy due diligence, representations-and-warranties insurance, escrow holdbacks, or a real price cut. Stock sales happen, but they need a buyer who is comfortable holding the entity’s history.

#The 338(h)(10) election: one election, two happy parties

IRC §338(h)(10) was made for exactly this situation: buyers who want asset economics, sellers who want stock economics.

#How it works

The deal closes as a legal stock sale. Both the buyer and seller jointly elect on Form 8023 to treat the deal as a deemed asset sale for tax purposes. Under this election, the law treats the target S-corp as if it sold all its assets at fair market value to a hypothetical unrelated buyer. Then it liquidated and gave the proceeds to shareholders.

The result for each party:

• Buyer: gets a full stepped-up basis in all target assets. The basis is allocated across Classes I through VII via Form 8883 (the asset allocation statement that goes with Form 8023)
• Seller: pays one level of tax, with gain character set by the deemed asset allocation (negotiated in the purchase agreement)
• Legal structure: stays a stock transfer, which keeps the seller’s liability profile closer to a stock deal

S-corps already avoid double tax as pass-through entities. So for S-corps, the §338(h)(10) election is mainly about giving the buyer the step-up while keeping the legal transaction clean. Both parties benefit.

#Who qualifies

For an S-corp target, you need to meet three conditions:

• The buyer must be a corporation (individuals, partnerships, and PE funds buying directly do not qualify)
• The buyer must make a qualified stock purchase (QSP): at least 80% of the target’s stock by vote and value, within a 12-month period
• Every S-corp shareholder must consent to the election, not just those who are selling (it affects the final pass-through K-1s that all shareholders get)

#The deadline: do not miss it

You must file the §338(h)(10) election no later than the 15th day of the 9th month after the month the acquisition date falls in. The acquisition date is the first day the buyer’s ownership reaches 80%. That is not always the closing date. Do not miss the deadline. If you do, you can ask the IRS for late-election relief through a private letter ruling. That costs time and fees, and it is not guaranteed.

#Character still matters inside the election

Even with a §338(h)(10) election, the deemed asset sale produces ordinary income on recapture assets, receivables, and inventory. You do not escape ordinary income treatment entirely. The advantage is one level of tax and a negotiated allocation. Push for more of the purchase price to go to Class VII goodwill (capital gain). Push for less to go to Class V equipment (recapture) or Class VI non-compete agreements (ordinary income). That negotiation lives in the purchase agreement, not in the tax filing.

#The 336(e) option: when the buyer will not consent

The §338(h)(10) election needs both parties to agree. What if the buyer is a PE fund, a family office, or an individual? Or what if the buyer simply refuses to make the joint election?

IRC §336(e) was finalized in Treasury Regulations published May 15, 2013. It extends similar treatment to cases where the buyer’s consent is not available, or not workable.

#How 336(e) differs from 338(h)(10)

Three key differences:

• The buyer does not need to be a corporation. Any buyer structure can receive 336(e) treatment.
• Multiple dispositions aggregate. You can sell to multiple buyers over 12 months and combine the sales to reach the 80% threshold.
• The seller makes the election unilaterally. Buyer consent is not required. The seller and the target entity enter a binding election agreement and attach a §336(e) election statement to the relevant tax return.

The tax result is economically the same as §338(h)(10): deemed asset sale, step-up basis for the buyer, one level of tax for the seller. There is no standalone IRS form yet for §336(e) elections. Practitioners use a modified Form 8883 to document the deemed asset disposition.

If your deal structure rules out §338(h)(10) because your buyer is a PE fund or individual, ask your advisor whether §336(e) applies. Do not assume asset sale terms are your only option.

#Built-in gains tax: the C-corp conversion trap

If your S-corp was ever a C-corp, or if it picked up assets in a carryover-basis deal from a C-corp, check one more layer: built-in gains (BIG) tax under IRC §1374.

#What it is and when it applies

When a C-corp converts to S-corp status, the IRS marks any assets with net unrealized built-in gains at the date of conversion. Say the S-corp sells those tainted assets within the 5-year recognition period (starting from the first day of the first S-corp tax year). The S-corp then pays a 21% entity-level tax on the recognized built-in gain. The entity pays this tax before any income passes through to you.

An S corporation that was always S has no BIG exposure on its own assets. It can still have exposure on assets it took over from a C corporation with carryover basis. This trap only hits converted C-corps, or an S-corp that took over C-corp assets in a carryover-basis deal.

#The math on a real example

Say your company converts from C-corp to S-corp in January 2023. At the conversion date, the business holds commercial real estate with a tax basis of $800,000 and a fair market value of $2,300,000. Built-in gain at conversion: $1,500,000.

The business sells in 2026, which is Year 4 of the 5-year period. If the same sale happened in 2029, that is Year 7, outside the window. (With the S election effective January 2023, 2023 is Year 1, so 2026 is Year 4. The recognition period ends December 31, 2027.) The real estate sells for $2,300,000.

• BIG tax at entity level: 21% x $1,500,000 = $315,000 paid by the S-corp
• The $315,000 BIG tax cuts the net income flowing through to your K-1
• You still pay individual-level tax on the remaining pass-through gain

If the same sale happened in 2029 (Year 7, outside the 5-year window), BIG tax is zero. The whole gain flows through at capital gain rates. Timing the exit right against the BIG window can easily swing hundreds of thousands of dollars on a mid-size deal.

#Planning around BIG tax

Three approaches work:

• Wait out the window. Say the recognition period expires in the next one to two years and you have flexibility on closing timeline. Waiting is often the right move.
• Allocate purchase price to real values. You can bargain over how assets are valued, but the allocation has to match real fair market values for each class. Do not move price just to avoid BIG tax. Get an appraisal for large assets. Under the residual method, each class is filled up to its fair market value before the next class.
• Net unrealized built-in loss offsets. BIG tax is computed on the net unrealized built-in gain across all assets. If some assets had unrealized losses at conversion, they reduce the BIG tax base.

For the full decision analysis on whether to convert from C-corp to S-corp, see C-corp to S-corp conversion and built-in gains. It also covers how the BIG recognition period affects that choice.

#Allocating purchase price with Form 8594

Say you close an asset deal, a §338(h)(10) deemed sale, or a §336(e) transaction. You must file Form 8594 (or Form 8883 for §338 elections) with your federal tax return for the year of the sale. So must the other party.

#The 7 asset classes in allocation order

Under IRC §1060, purchase price gets allocated to these classes in order, using up each one before moving to the next:

• Class I: Cash and general deposit accounts
• Class II: Actively traded personal property and government securities
• Class III: Accounts receivable and credit card receivables from ordinary business
• Class IV: Inventory and property held primarily for sale to customers
• Class V: All other tangible assets (equipment, furniture, vehicles, real estate)
• Class VI: Section 197 intangibles other than goodwill (customer lists, non-compete agreements, patents, licenses, trade names)
• Class VII: Goodwill and going concern value (absorbs whatever purchase price remains after all other classes)

Why this matters for your after-tax proceeds: the allocation directly sets your gain character. More price to Class VI non-compete agreements means more ordinary income for you as the seller. More to Class VII goodwill means more capital gain. This is a negotiation point inside the deal. Push for as much of the leftover amount as possible to land in Class VII.

#The matching requirement and what happens when it breaks

Both the buyer and the seller file Form 8594. If the numbers do not match, the IRS can notice and ask questions. Agree on one allocation in the contract, and both sides should file the same numbers. When the two allocations do not match:

• Both returns get flagged, which raises audit risk for both parties
• The IRS has authority to substitute its own valuation and allocation under §1060
• Both parties face potential substantial valuation misstatement penalties under §6662. These run 20% to 40% of additional tax owed, depending on how far off the valuation is

The fix is simple. Agree on the exact allocation in the purchase agreement before closing. Put it in writing. Make sure your tax preparer files numbers identical to the buyer’s. Lock the allocation into the contract. Do not reconstruct it after closing.

#A note on §338(h)(10) and Form 8883

For §338(h)(10) elections, the buyer files Form 8023 (the election itself). Both parties use Form 8883 (Asset Allocation Statement Under §338) to document the deemed purchase price and its allocation across Classes I through VII. Form 8883 follows the same framework as Form 8594 and carries the same matching requirement.

#Common questions

Is the §338(h)(10) election always better for the seller than a straight asset sale? Not always. The character of gain in a §338(h)(10) deemed sale is the same as in a real asset sale: ordinary income on recapture assets, capital gain on goodwill. An S corporation already avoids double tax, so the election does not remove a second layer of tax for the seller. The election’s value to you is a higher price from a buyer who gets a step-up. The deal still closes as a stock sale. Say you have a deal with heavy ordinary income character: lots of equipment recapture, a large AR balance. Your after-tax result may be close to a plain asset sale. The election is most valuable when two things are true: the buyer offers a price premium for the step-up, and you want to avoid the liability carryover of a pure stock deal.

What if one of my S-corp shareholders refuses to sign the 338(h)(10) election? The election fails. Section 336(e) also needs every S-corp shareholder, including shareholders who sell nothing, to sign the binding election agreement, just as for 338(h)(10). It helps when the buyer is not a corporation or will not join the election. It does not fix a holdout owner. This is a real issue in multi-owner S-corps where shareholders have different cost bases or tax situations.

Does the 338(h)(10) election affect my S-corp’s final tax return? Yes. When you make a §338(h)(10) election, the target S-corp files a final Form 1120-S reporting the deemed asset sale. All gain flows through to shareholders on final K-1s, and the S-corp ends after the deemed liquidation. This is separate from the legal stock transfer. See S-corp termination and revocation mechanics for how the final return and entity wind-down work.

Can I time the deal to avoid built-in gains tax? Yes, if you have flexibility on the closing date. The BIG recognition period is exactly 5 years from the first day of the first S-corp tax year. If the window expires in 8 months, waiting can save you a 21% entity-level tax on millions of dollars of built-in gain. Plan for this well before you sign a letter of intent, not after. Build your BIG expiration date into your exit timeline from day one.

What assets are excluded from the built-in gains calculation? Only assets with unrealized appreciation that existed at the date of C-corp to S-corp conversion carry BIG taint. Assets the S-corp acquires after the election date are clean. The BIG calculation uses the “net unrealized built-in gain” set at conversion, which needs a snapshot valuation as of the election date. Many converted S-corps do not have a formal appraisal from the conversion date and struggle to establish the baseline at exit. If you are approaching a sale and you converted years ago, reconstruct that baseline now.

Does the buyer need to know about built-in gains exposure? Yes, and thorough buyers will ask. A typical due diligence package includes a review of the company’s S-corp election history. If your S-corp converted from a C-corp, the buyer’s advisors will ask for the conversion date, conversion-date valuations, and the recognition period calculation. BIG tax lowers your effective exit proceeds and affects deal pricing. Failing to disclose it creates post-closing indemnification exposure.

Is Form 8594 required if we use a 338(h)(10) election? In a §338(h)(10) transaction, the allocation is reported on Form 8883, not Form 8594. Form 8594 covers direct asset acquisitions under §1060. Form 8883 covers the deemed asset sale under §338. Both use the same Class I through VII framework and both carry the same IRS matching requirement between buyer and seller. Your deal structure sets which form applies, so make sure your advisor files the right one.

What if the deal involves an installment sale or earnout? Installment sales (purchase price paid over multiple years) add complexity. Under IRC §453, you report gain as you receive payments. The gain character on each installment is spread across the Form 8594 (or 8883) classes. Even with a seller note, depreciation recapture and inventory gain are taxed in the year of sale. Only the rest of the gain can be spread over the payments. If your deal includes a seller note or earnout, structure and model the installment treatment before you sign.

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Selling an S-corp is one of the biggest financial events you will go through. You need to decide on the structure (asset sale, stock sale, or §338(h)(10)) before you sign the LOI, not after. We have worked with S-corp owners on exits across a range of deal sizes, and we know where sellers leave money on the table. Book a 20-minute Tax Discovery and bring the term sheet if you have one. We will review the structure, flag the BIG exposure, and show you what the different allocations actually cost you. Visit tax planning and advisory services to see how we support S-corp owners through exits. Free advice either way.