S‑Corp basics that drive exit tax outcomes

• An S corporation is a domestic corporation that has made and maintained a valid S election; it generally pays no federal income tax at the entity level and passes income and losses to shareholders to report on their personal returns. There are eligibility, filing, and compliance requirements unique to S‑corps S corporations.

• The S corporation files Form 1120‑S; shareholders receive Schedule K‑1 for their share of income, loss, and other items, and the S corporation must meet e‑file and other filing logistics (including deadlines and statements) 2024 Instructions for Form 1120‑S.

• Shareholder stock and debt basis are critical in any exit because they determine gain/loss on a stock sale, and affect the taxability of any pre‑sale distributions. Maintain accurate basis schedules; distributions in excess of stock basis are taxable capital gains, and loss deductions can be limited by basis Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S).

Asset sale vs. stock sale: tax pros and cons

• Buyers frequently prefer asset deals to get a tax “step‑up” into the purchased assets; sellers often prefer stock deals for simplicity and favorable capital gain tax treatment. For S‑corp owners, the key differences are:

  • Asset sale (S‑corp sells assets)

    • Entity‑level tax: The S‑corp recognizes gain (and sometimes loss) on the sale of its assets. Gain character depends on the assets—capital, Section 1231, or ordinary (for example, depreciation recapture)—as provided in the sales and dispositions rules; these gains are passed through to shareholders and reported on their returns Publication 544.

    • Built‑in gains tax (BIG): If the S‑corp has net unrealized built‑in gain from C‑corp years or acquired C‑corp assets, an entity‑level corporate tax can apply to the S‑corp’s net recognized built‑in gain during the 5‑year recognition period. The Schedule D instructions outline mechanics, limitations, and reporting for BIG Instructions for Schedule D (Form 1120‑S).

    • Shareholder‑level tax: Any sale gains/losses pass through and are taxed to shareholders. Pre‑exit distributions and year‑end basis calculations still matter (to determine taxability of distributions and timing of suspended losses) Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S).

    • Buyer benefit: Buyer receives a stepped‑up basis in purchased assets, potentially yielding larger future depreciation/amortization deductions Publication 544.

  • Stock sale (shareholders sell their shares)

    • Entity‑level tax: Generally, no entity‑level gain/loss is recognized by the corporation solely because shareholders sell stock. The S‑corp continues; ownership changes don’t themselves trigger corporate‑level tax unless accompanied by other transactions S corporations.

    • Shareholder‑level tax: Selling shareholders typically realize capital gain or loss on the sale of their stock (subject to basis and holding period), often simpler and potentially more favorable than an asset sale when ordinary income would have been generated by appreciated § 1245/§ 1250 property in an asset sale Publication 544.

    • Buyer downside: Buyer generally takes the target’s historic basis in assets inside the corporation (no automatic step‑up). Buyers may negotiate price adjustments or seek elections to achieve asset sale treatment Publication 544.

Section 336(e) election: treating a stock sale as a deemed asset sale

• For S‑corp targets, a stock disposition can be treated as a deemed asset sale under a joint election (Section 336(e)), which aligns the tax results with a sale of the target’s assets (deemed sale by “old target,” deemed purchase by “new target,” followed by a deemed liquidation). While the detailed regulations are technical, the effect is similar to an asset sale with pass‑through of gain/loss and potential BIG exposure where applicable Instructions for Schedule D (Form 1120‑S).

  • Seller perspective: A 336(e) election in a stock sale can produce pass‑through gain similar to an asset sale, including the potential for BIG tax if applicable; transaction design must account for built‑in gains exposure and character of asset‑level gains Instructions for Schedule D (Form 1120‑S).

  • Buyer perspective: Achieves a step‑up in the target’s assets (like an asset sale), often improving future deductions Publication 544.

Complete liquidation: mechanics and tax results

• If you plan to shut down and liquidate the S‑corp rather than sell equity or assets, model both corporate‑level and shareholder‑level consequences:

  • Corporate‑level recognition: On a distribution of property in complete liquidation, the liquidating corporation recognizes gain or loss as if it sold the property at fair market value; the gain/loss flows through to shareholders on Schedule K‑1 Publication 544; Instructions for Schedule D (Form 1120‑S).

  • Shareholder‑level treatment: Amounts received by a shareholder in complete liquidation are treated as full payment in exchange for the stock, generally producing capital gain or loss measured against the shareholder’s basis. Form 1120‑S and Schedule K‑1 reporting reflect these exchange‑based results 2024 Instructions for Form 1120‑S; Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S).

  • Installment obligations received in liquidation: If the liquidating corporation sells assets and distributes buyer installment obligations to shareholders, qualifying shareholders generally report payments on the installment method rather than on receipt of the obligation (subject to exceptions). Publication 544 provides installment sale reporting guidance and references to Form 6252 Publication 544.

Built‑in gains tax: planning and compliance

• Section 1374 can impose an entity‑level corporate tax on an S corporation’s net recognized built‑in gain when it converted from C‑corp status or acquired carryover‑basis assets from a C corporation. Planning focuses on whether recognition occurs inside the 5‑year period and your measured net unrealized built‑in gain (NUBIG) Instructions for Schedule D (Form 1120‑S).

  • Recognition period: The BIG recognition period is 5 years beginning on the first day of the first S‑corp year (or, for carryover assets, beginning on the day the S‑corp acquired the property) Instructions for Schedule D (Form 1120‑S).

  • Entity‑level rate and computation: Tax applies at the highest corporate rate to net recognized built‑in gain, subject to taxable income limitations; the instructions outline use of C‑corp net operating loss and capital loss carryforwards and certain credits against BIG Instructions for Schedule D (Form 1120‑S).

  • Reporting: S‑corps report built‑in gains tax on Schedule D (Form 1120‑S), Part III, and must track NUBIG/NRBIG, limitations, and any carryforwards Instructions for Schedule D (Form 1120‑S).

  • Planning considerations:

    • Transaction timing: If feasible, defer recognition events (asset sale or 336(e) stock‑as‑asset election) until after the 5‑year period to avoid BIG tax Instructions for Schedule D (Form 1120‑S).

    • Loss and credit utilization: Model whether pre‑S net operating loss carryforwards and business credits can offset BIG Instructions for Schedule D (Form 1120‑S).

    • Character management: Recognized gains in an asset sale reflect the character of each asset (ordinary vs. capital vs. Section 1231), which can affect owners’ personal tax; Publication 544 and Form 1120‑S instructions guide transaction‑level reporting Publication 544; 2024 Instructions for Form 1120‑S.

Putting it together: seller and buyer tax priorities

• Seller priorities

  • Maximize long‑term capital gain on exit (stock sale or liquidation exchange treatment), minimize ordinary income from depreciation recapture in asset‑level sales, and avoid or mitigate BIG tax Publication 544; Instructions for Schedule D (Form 1120‑S).

  • Confirm shareholder basis and AAA/other account balances to avoid unintended capital gain from pre‑sale distributions and to properly report gain/loss 2024 Instructions for Form 1120‑S; Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S).

  • If buyer needs a step‑up, consider a 336(e) election in a stock sale so the purchase is treated as an asset acquisition for tax purposes (with corresponding corporate‑level gain/loss and possible BIG exposure) Instructions for Schedule D (Form 1120‑S).

• Buyer priorities

  • Prefer asset sales or a 336(e) election so the target’s assets get a stepped‑up basis, increasing future depreciation/amortization deductions Publication 544.

  • Understand legacy tax attributes in stock purchases (no automatic step‑up) and negotiate price or tax covenant protections accordingly Publication 544.

Pros and cons summary: asset vs. stock sale

• Asset sale

  • Pros (Buyer): Step‑up in asset basis; targeted purchase of desired assets/liabilities Publication 544.

  • Cons (Seller): Potential ordinary income from recapture; possible entity‑level BIG tax within 5‑year period; more complex transaction and reporting Instructions for Schedule D (Form 1120‑S); 2024 Instructions for Form 1120‑S.

• Stock sale

  • Pros (Seller): Typically long‑term capital gain; simpler corporate reporting (no asset‑level recognition solely due to stock sale) Publication 544.

  • Cons (Buyer): No automatic asset basis step‑up; diligence around historic liabilities and attributes; may seek 336(e) to convert to deemed asset sale Instructions for Schedule D (Form 1120‑S).

Practical steps and documentation

• Model both structures early, including shareholder basis, projected gain character, and whether BIG tax applies; reflect results on Form 1120‑S and Schedule D as required 2024 Instructions for Form 1120‑S; Instructions for Schedule D (Form 1120‑S).

• If liquidating, track corporate recognition under the liquidation rules and shareholder exchange treatment. If distributing installment obligations, apply the installment sale rules and report subsequent payments properly (including Form 6252, if applicable) Publication 544.

• For a stock sale where the parties desire asset sale tax treatment, evaluate and properly implement a Section 336(e) election; ensure documentation and timing reflect the regulations and reporting mechanics in the Schedule D instructions Instructions for Schedule D (Form 1120‑S).

• Keep immaculate records for AAA, OAA, AE&P (if any), and shareholder basis to support gain/loss, distribution taxability, and pass‑through reporting to owners 2024 Instructions for Form 1120‑S; Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S).

Bottom line

An S‑corp exit is a design exercise: choose stock sale for simplicity and potential capital gain, choose asset sale (or a 336(e) election) to deliver a buyer basis step‑up, and plan around built‑in gains tax and asset‑level gain character. Coordinate liquidation mechanics (if that’s your path) to align corporate and shareholder reporting. With early modeling and the right election strategy, you can capture value while staying compliant with the Code and regulations governing S‑corporation sales and exits S corporations; Instructions for Schedule D (Form 1120‑S); 2024 Instructions for Form 1120‑S; Publication 544.