Generally, buyers of businesses want to buy assets so they can take a step up on a tax basis. Sellers prefer to sell stock, so their gain will be taxable at favorable capital gains rates. Some gain is usually taxable at higher ordinary income tax rates in an asset sale. Accordingly, S corporation owners who have been asked to sell assets typically request, and buyers typically agree to, an increase in the purchase price to account for the additional tax costs – a “tax gross-up.”

Since 2018, the federal income tax deductibility of state taxes for individuals has been limited to $10,000, but 36 states have now adopted a workaround known as pass-through entity tax elections (PTE election). A PTE election enables owners of S corporations and partnerships to have the company pay the owner’s state income tax on the income from the company. That state income tax paid by the entity is fully deductible for federal income tax purposes. The IRS approved such planning, which avoids the $10,000 limit (Ruling 2020-75). In a sale of stock, the PTE election is not available.

So, for instance, in a sale of stock with a gain of $1 million subject to 20% federal capital gains tax and 10% income tax (e.g., Minnesota’s rate), the state income tax would only be deductible up to $10,000 so the total federal and state income tax liability would be $298,000 (a savings from the state tax deduction of $2000). By contrast, if the S corporation had that same $1 million gain and 20% of that gain was taxable at ordinary income tax rates (37%), the additional tax would be 17% of $200,000 (i.e., $34,000).  If the S corporation made a PTE election and deducted the full $100,000 of state taxes paid, its tax savings of $37,000 (37% of $100,000) more than offsets the additional income tax from selling assets. Obviously, the amount of ordinary income and state income tax rates in a particular case will impact this calculation.

Bottom line. When considering an asset sale versus a stock sale and the need for a tax gross-up, don’t forget to consider the impact of a PTE election.

“When in doubt, look intelligent.” — Garrison Keillor

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Photo of James Duffy James Duffy

Jim is a partner in Taft’s Tax practice and practices principally in the areas of federal tax law; tax credit financing; individual, partnership and corporate tax planning; M&A; tax-exempt organizations and general commercial and corporate law.

Jim has been actively practicing in the

Jim is a partner in Taft’s Tax practice and practices principally in the areas of federal tax law; tax credit financing; individual, partnership and corporate tax planning; M&A; tax-exempt organizations and general commercial and corporate law.

Jim has been actively practicing in the area of the New Markets Tax Credits (NMTC) program since its inception in 2001. He has organized community development entities (CDEs) and represented CDEs, borrowers and other parties in structuring and closing numerous NMTC transactions. Jim also advises clients regarding Qualified Opportunity Zone matters.

Jim advises LLCs, partnerships, corporations and individuals in connection with the formation of new companies, mergers and acquisitions, formation of joint ventures, like-kind exchanges, ownership succession planning, and general business operations. These clients are involved in a variety of industries, including banking, venture capital, real estate, construction, consulting and investing.

Jim also advises charitable and non-charitable tax-exempt organizations, including health care entities, schools, religious and civic organizations. In addition to advising management of these organizations with respect to matters pertaining to general operation and maintenance of tax-exempt status, Jim has assisted clients in forming, restructuring and dissolving tax-exempt organizations, as well as forming donor- advised funds.

Prior to joining the firm, Jim worked at the law firm of Lewis Rice and Fingersh in St. Louis, Missouri, where he concentrated his practice in federal and state taxation. He also clerked for the Hon. Robert P. Ruwe of the U.S. Tax Court in Washington, D.C.

Photo of Nathan J. Hagerman Nathan J. Hagerman

Nathan provides legal counsel and tax advice for domestic and international transactions involving business assets and aircraft, including structuring, planning and drafting deals. He has been practicing in the area of multistate taxation since 1996. He counsels business clients in all areas of

Nathan provides legal counsel and tax advice for domestic and international transactions involving business assets and aircraft, including structuring, planning and drafting deals. He has been practicing in the area of multistate taxation since 1996. He counsels business clients in all areas of state and local taxes, including controversies, administrative proceedings, audits, appeals, litigation, and planning. Nathan has presented before numerous industry and professional organizations on various state and local taxation matters. A summary of Taft’s aircraft transaction experience is available here.

Prior to joining Taft, Nathan was the Indiana practice leader for Multistate Taxes at a national consulting firm. He also managed the tax function of a Fortune 500 insurance company headquartered in Indiana for more than four years.

Nathan earned his J.D. from the University of Michigan Law School and his Bachelor of Arts degree from Purdue University.