Contents
- The deal structure dilemma: stock vs asset sales
- QSBS (1202): the primary exclusion mechanism
- Section 1045 rollovers: deferral when you exit too early
- Section 338 elections: engineering a step-up
- Personal goodwill: escaping double tax (when facts support it)
- Tax-free reorganizations (368) and boot character
- Advanced pre-transaction planning: gifts, GRATs, QSBS stacking
- SALT reality: QSBS state conformity and residency risk
1) Stock vs asset sale: why buyers and sellers fight
The foundational mismatch drives everything: buyers prefer asset deals (or asset-deal economics) for a basis step-up and future depreciation/amortization, while sellers prefer stock sales for single-level capital gain and to avoid corporate-level tax. In C Corps, an actual asset sale can produce a combined effective rate that’s dramatically higher than a stock sale because the corporation pays tax first and shareholders pay again on distributions. :contentReference[oaicite:2]{index=2}
Asset sale (seller pain, buyer gain)
Corporate gain taxed at 21% (plus state), then shareholder tax on distribution; buyer gets step-up (including goodwill). :contentReference[oaicite:3]{index=3}
Stock sale (seller gain, buyer pain)
Single level of shareholder tax; buyer inherits historical basis and may discount price to compensate. :contentReference[oaicite:4]{index=4}
2) QSBS (1202): the primary exclusion mechanism for founders and early investors
Section 1202 can invert the C Corp “double tax” narrative by excluding up to 100% of gain on qualifying stock held more than five years, subject to per-issuer caps (the greater of $10M or 10x basis). The benefit depends heavily on “stock vintage” (issuance date) and strict eligibility requirements like the $50M gross assets test (measured largely by tax basis) and the 80% active business asset test. :contentReference[oaicite:5]{index=5}
Two QSBS traps that wreck rounds
Anti-churning and redemption rules can disqualify QSBS if the corporation buys back shares from related parties around issuance windows, or if it redeems more than certain thresholds in the defined periods. Treat repurchases as a “QSBS-sensitive” action, especially near financings. :contentReference[oaicite:6]{index=6}
$10M vs 10x basis cap
The 10x basis path can dwarf $10M in certain “stuffing” patterns, but it is highly fact-dependent and requires disciplined basis tracking. :contentReference[oaicite:7]{index=7}
Active business safe harbor
Startups can hold working capital for anticipated needs under a statutory safe harbor, but you still need a narrative and evidence of active business intent. :contentReference[oaicite:8]{index=8}
3) Section 1045 rollovers: deferral if you exit before 5 years
If you sell QSBS after more than six months but before meeting the five-year holding period, Section 1045 can defer the gain if you reinvest in replacement QSBS within 60 days. The holding period can tack, but the replacement entity must be a real active business—cash “parking” invites challenge. Partnership-level timing can be especially tight because the 60-day window can run from the partnership’s sale date, not when proceeds are distributed. :contentReference[oaicite:9]{index=9}
4) Section 338 elections: manufacturing an asset step-up
Section 338(h)(10) is the classic compromise (available in S Corp and consolidated-sub contexts) that gives the buyer a step-up while producing a single level of tax for the seller in many cases. By contrast, 338(g) for standalone domestic C Corps often functions as a “trap”—the target bears deemed-asset-sale tax, which the buyer effectively pays after acquiring the stock. Gross-up negotiations often determine whether a step-up deal is still positive NPV for the buyer. :contentReference[oaicite:10]{index=10}
Why gross-ups happen
Buyers may be willing to gross up sellers because the present value of the depreciation/amortization tax shield (especially goodwill amortization) can exceed the incremental tax cost to the seller—so both sides can win if modeled correctly. :contentReference[oaicite:11]{index=11}
5) Personal goodwill: bifurcating value to reduce (or avoid) double tax
Under the Martin Ice Cream doctrine, goodwill is not automatically corporate property. If customer relationships and value are truly personal to the founder (and not already assigned to the corporation via employment agreements or non-competes), a portion of deal consideration may be allocated to the founder’s personal goodwill—taxed once to the individual, rather than twice through the corporation. This is powerful but scrutinized: documentation, valuation, and “bad facts” (like existing covenants) can sink it. :contentReference[oaicite:12]{index=12}
6) Tax-free reorganizations (368): when consideration includes acquirer stock
When the acquirer offers stock, Section 368 can provide tax deferral for the stock portion, with cash “boot” taxed currently. Structure choice matters: A (merger) is flexible, B (stock-for-stock) is rigid (no boot), and C (asset-for-stock) has “substantially all” constraints. Triangular structures are common to preserve target legal existence and manage liabilities. Boot character can depend on Section 302-style analyses under the Clark framework. :contentReference[oaicite:13]{index=13}
QSBS in reorgs: the “freeze” concept
If QSBS is exchanged for non-QSBS (e.g., public company stock) in a tax-free reorganization, the QSBS benefit generally “freezes” to built-in gain at closing: future appreciation in the acquirer stock is typically not QSBS-excludable. :contentReference[oaicite:14]{index=14}
7) Pre-transaction planning: the window closes earlier than founders think
The pre-LOI window is often the last reliable time to move value: gifts to charity (DAFs/CRTs), GRATs to shift pre-IPO growth, and QSBS “stacking” via non-grantor trusts that each claim their own cap. The assignment-of-income doctrine can recharacterize last-minute gifts as if the donor sold first—so timing around deal inevitability is the central risk variable. :contentReference[oaicite:15]{index=15}
GRATs for high-growth stock
GRATs can shift upside above the 7520 hurdle rate; for founders, they’re often most potent pre-IPO when volatility and growth are highest. :contentReference[oaicite:16]{index=16}
QSBS stacking via trusts
Multiple “taxpayer” entities can multiply 1202 caps, but trusts must be drafted to avoid grantor status and avoid aggregation under multiple-trust rules. :contentReference[oaicite:17]{index=17}
8) SALT: QSBS state conformity and residency audits can dominate outcomes
Even when federal tax is zero under QSBS, state tax can be large in nonconforming states (notably California). Residency changes need to be real and defensible—last-minute moves are commonly challenged. Trust-based state planning has also tightened as states close perceived loopholes. :contentReference[oaicite:18]{index=18}
Bottom line
The best exit tax outcomes are designed, not negotiated. Start with QSBS eligibility and redemption hygiene, then map fallback options (1045, 368 structures, goodwill bifurcation, 338 modeling). Finally, execute pre-transaction planning early enough to avoid assignment-of-income risk and to withstand state residency scrutiny. :contentReference[oaicite:19]{index=19}