Tax Law ✦ Business Sale & M&A
The Tax on the Sale Is Decided at the Letter of Intent.
Asset sale or stock sale, purchase price allocation, installment terms, earnouts, the seller’s move out of state, and the California rules that do not follow the federal ones: each is worth real money, and each is settled before the purchase agreement is drafted. North Star Law Firm structures the tax side of buying and selling California businesses and drafts the deal documents to match. Attorney-CPA. Flat fees. Statewide.
The Short Answer
Buyers want assets. Sellers want stock. The price of the difference is negotiable.
A buyer who purchases assets gets a fresh, stepped-up basis to depreciate and leaves the seller’s liabilities behind. A seller who sells stock or membership interests gets capital gain on the whole price and walks away clean. Those interests conflict, and the gap is bridged with price, with allocation, and with structures like the Section 338(h)(10) election or an F reorganization that let a stock sale be taxed like an asset sale. Then California adds its layer: no preferential capital gains rate, no qualified small business stock exclusion, a successor-liability regime that follows unpaid sales and payroll tax to the buyer, and a rule that keeps taxing an installment note after the seller has moved to Nevada. We negotiate all of it, and we draft the agreement so the tax terms are in the document rather than in the parties’ memories.
- Asset versus stock sale analysis for buyer and seller, with the after-tax proceeds modeled
- Purchase price allocation under I.R.C. § 1060 and Form 8594; goodwill, non-compete, and consulting allocations
- Section 338(h)(10) and 336(e) elections; F reorganizations; S corporation and LLC target structures
- Installment sales under § 453, earnouts, seller notes, and rollover equity
- California: CDTFA and EDD clearance certificates, successor liability, bulk sale notices, and nonresident sourcing
- Due diligence performed by a CPA: financial statements, tax returns, payroll, and sales tax exposure
The Decisions
What is decided in a business sale, and what it is worth
Every line below is a negotiation, and every one is usually settled by the time the letter of intent is signed, whether or not the parties realize it.
| Decision | Seller’s preference | Buyer’s preference | What resolves it |
|---|---|---|---|
| Asset or stock | Stock: one level of capital gain, liabilities stay with the company | Assets: stepped-up basis, no inherited liabilities | Price adjustment; § 338(h)(10) election for S corporation targets; F reorganization for LLC conversions |
| Allocation (§ 1060) | More to goodwill and capital assets, taxed as capital gain | More to equipment and inventory, recovered quickly; more to a consulting agreement, deductible immediately | Negotiated allocation schedule attached to the agreement, reported identically on Form 8594 |
| Payment terms | Cash at close, or installment reporting to spread the gain | Seller financing and earnouts to shift risk | Installment sale under § 453; earnout terms drafted so the contingent payments are capital gain, not compensation |
| Non-compete | Small allocation (ordinary income to seller) | Large allocation (15-year amortization) or none | Allocation negotiated with the total after-tax picture in view |
| Entity clean-up | Sell before the S election lapses or the LLC’s built-in gains matter | A target with clean books and filed returns | Pre-sale restructuring, often an F reorganization, done months before marketing the business |
| California clearances | Deliver them so the price is not held back | Require them to avoid successor liability (R&TC §§ 6811 to 6814; Unemp. Ins. Code § 1731) | CDTFA and EDD clearance certificates requested at signing, escrow holdback until received |
Why the seller’s move out of state does not end California tax
Sellers who plan to leave California after a sale often assume the state’s share of the gain leaves with them. It does not, in two situations. Gain on the sale of a California business’s assets, or of an interest in an entity whose assets are in California, is California-source income and is taxed to a nonresident under R&TC § 17951. And an installment note received while a California resident carries the deferred California gain with it: the FTB taxes each installment as it is received, or may accelerate the remaining gain when residency ends, depending on how the sale was structured. A seller who wants to relocate needs the residency change completed, documented, and defensible before the sale closes, and the structure chosen with the sourcing rules in mind. The FTB audits exactly this fact pattern.
What about qualified small business stock?
Federally, I.R.C. § 1202 excludes up to $10 million (or ten times basis) of gain on qualified small business stock held five years, and the 2025 federal changes expanded the exclusion for stock issued after mid-2025. California does not conform. The state repealed its QSBS exclusion in 2013 and taxes the entire gain at ordinary rates up to 13.3 percent. That does not make a C corporation the wrong choice for a venture-backed company, but it changes the math for a founder deciding between an S corporation and a C corporation with a California exit in mind, and it is one more reason the residency planning above matters.
What does a CPA-led due diligence find?
The things that become price reductions or indemnity claims later: unpaid sales tax that the buyer inherits without a clearance certificate, workers classified as contractors who will be reclassified by the EDD, payroll tax deposits that were missed, an S election that was never valid, inventory that is not what the balance sheet says, revenue recognized before it was earned, and related-party transactions that will not survive the seller’s departure. On the sell side, the same review done a year before marketing the business fixes the problems before a buyer’s accountant finds them and prices them.
The Attorney-CPA Difference
The purchase agreement is a tax return with signature blocks.
- After-tax proceeds modeled under each structure before the letter of intent
- Allocation, installment, and earnout terms negotiated and drafted into the agreement
- F reorganizations and § 338(h)(10) elections executed on time
- California clearances, successor liability, and nonresident sourcing handled at closing
- Due diligence by a CPA who has reviewed hundreds of sets of books
Questions & Answers
Business sale questions California owners ask
How much tax will I pay when I sell my business?
It depends on structure, allocation, and your residency, which is why the question is answered with a model rather than a rate. Federally, most of the gain is capital gain at 20 percent plus 3.8 percent; California adds up to 13.3 percent on all of it. The allocation and installment decisions move the total by meaningful amounts.
Is an installment sale a good idea?
Often, for spreading the gain across years and staying below rate thresholds, but it carries the buyer’s credit risk and, in California, the sourcing issue if you plan to move. Interest must be charged at the applicable federal rate, and depreciation recapture is taxed in the year of sale regardless.
What is an F reorganization and why do buyers ask for one?
A pre-sale restructuring in which the target S corporation becomes a subsidiary of a new holding company and converts to an LLC, so the buyer can purchase the LLC interests and get asset-sale tax treatment while the seller keeps the S corporation’s history and tax attributes. It has become the standard structure for private equity purchases of S corporations.
Do I need a bulk sale notice in California?
Only if the seller’s principal business is selling inventory from stock (including restaurants) and the sale is of substantially all the assets outside the ordinary course (Com. Code § 6101 et seq.). Most service businesses do not; most retailers and restaurants do, and the notice and escrow requirements are strict.
The structure is worth more than the last five percent on price.
A free deal review with an attorney-CPA, and a flat fee in writing for the tax structuring and the agreement.