S-Corp Asset Sale vs. Stock Sale:
The Tax Analysis Sellers Must Understand

Buyers prefer asset sales because they get a stepped-up tax basis in the acquired assets equal to the purchase price. This allows the buyer to depreciate and amortize the assets from their full current value rather than the seller's often much lower historical cost. For a buyer acquiring an S-corp at $5M with assets worth $5M on the books but originally purchased for $500K, the asset sale provides $4.5M of additional depreciation and amortization opportunity. This creates significant post-acquisition tax savings. In a stock sale without a 338(h)(10) election, the buyer inherits the seller's old basis and loses those future deductions.

S-corporations are pass-through entities - the corporation itself does not pay federal income tax (with certain exceptions like built-in gains tax). Gains from a sale flow through directly to the shareholders on their individual tax returns. In a stock sale, shareholders typically report capital gain on the sale of their stock. In an asset sale, the corporation first recognizes gain at the asset level (allocating to each asset class), which flows through to the shareholders who report it on their individual returns. The key risk in an S-corp asset sale is that some asset gains (depreciation recapture, for example) are ordinary income rather than capital gains, which increases the seller's effective tax rate. This is why sellers generally prefer stock sales for S-corps when possible.

The built-in gains (BIG) tax applies when an S-corporation was previously a C-corporation and converted to S-corp status. If the S-corp disposes of assets that had unrealized appreciation at the time of conversion, a corporate-level tax (at the highest corporate rate, currently 21%) is imposed on those 'built-in gains.' The BIG tax applies for 5 years after the C-to-S conversion. Sellers of S-corps that were recently converted from C-corps must factor this into their deal economics - the BIG tax effectively creates a double-tax scenario on appreciated assets, reducing the economic benefit of the S-corp structure for the first 5 years post-conversion.

The 338(h)(10) election is specifically designed for S-corp acquisitions. It allows a stock purchase to be treated as an asset sale for tax purposes. The buyer gets the stepped-up basis they want. The transaction proceeds mechanically as a stock sale - no individual asset assignments. The seller recognizes gain as if the S-corp sold its assets (rather than stock), which typically results in higher tax than a pure stock sale. The buyer compensates the seller for this incremental tax cost with a 'tax gross-up' payment - essentially sharing the value of the stepped-up basis. For S-corp deals where buyer and seller are far apart on asset vs. stock structure, the 338(h)(10) election with a negotiated gross-up is frequently the path to closing.

Yes. Because the 338(h)(10) election requires joint filing by the buyer and the S-corporation's shareholders, all shareholders must consent. If any shareholder objects, the election cannot be made. This creates a potential problem in multi-shareholder S-corps where shareholders have different tax profiles and some would be more adversely affected by the election than others. Structuring the gross-up payment to adequately compensate each shareholder for their specific incremental tax burden requires careful tax modeling. A selling shareholder with a very low basis in their stock (high gain) will owe more in tax under the election than a shareholder who paid full price in a recent buy-in. The gross-up must be allocated fairly among shareholders to get universal consent.