The tax treatment of a stock acquisition starts from two defaults: the selling shareholder owes capital gains tax on the profit, and the buyer takes a cost basis in the shares while the target company keeps its old, historical basis in its underlying assets. Several elections and structures can change that outcome, sometimes dramatically. Section 338 and Section 336(e) elections convert the deal into a deemed asset purchase. A Section 368 reorganization can defer the seller’s tax entirely. Section 1202 can wipe out most of the gain on qualifying small business stock. Section 453 spreads the tax over the years payments arrive. Getting the structure right can move millions of dollars from one side of the closing table to the other.
How the Seller Is Taxed
A shareholder selling stock computes gain by subtracting adjusted basis (usually what they originally paid) from the total consideration received, including cash and the fair market value of any non-cash property.1Office of the Law Revision Counsel. 26 USC 1001 – Determination of Amount of and Recognition of Gain or Loss Unless a deferral rule applies, the gain is recognized at closing.
Holding period drives the rate. Stock held one year or less produces short-term gain taxed at ordinary rates, which run from 10% to 37% in 2026. Stock held longer than a year qualifies for long-term capital gains rates:
- 0% on taxable income up to $49,450 for single filers or $98,900 for joint filers.
- 15% above those thresholds up to $545,500 (single) or $613,700 (joint).
- 20% on amounts above.
Higher earners also owe a 3.8% Net Investment Income Tax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds $200,000 (single) or $250,000 (joint). Those thresholds are not indexed for inflation.2Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Capital gain from a stock sale counts as net investment income.3eCFR. 26 CFR 1.1411-4 – Definition of Net Investment Income
Sellers report the transaction on Form 8949 and Schedule D.4Internal Revenue Service. Instructions for Form 8949 Underreporting can trigger a 20% accuracy-related penalty on the underpayment.5Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Sellers usually prefer stock sales over asset sales because a stock sale is taxed only at the shareholder level, not at the corporate level followed by a distribution tax.
How the Buyer Is Taxed
The buyer’s basis in the acquired shares equals the purchase price.6Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property; Cost That outside basis affects a future sale of the target’s stock but changes nothing inside the target. The target keeps depreciating its equipment, real estate, and intangibles from their original historical values.
This is the core drawback of a stock purchase for buyers. A buyer paying a premium over book value ends up with a high outside basis in the stock and an unchanged, lower inside basis in the assets. The target generates the same taxable income going forward, with no extra depreciation or amortization to reflect what the buyer actually paid. Closing that gap requires a Section 338 or 336(e) election.
Legal fees, due diligence, and other transaction costs are generally not immediately deductible. They must be capitalized into the buyer’s basis in the stock, so the benefit only comes through on a later disposition.
Section 338 and 336(e) Elections: Getting Asset-Sale Treatment
Sections 338 and 336(e) let the parties treat a stock purchase as if the target had sold all its assets to a new corporation and repurchased them at fair market value the next day.7Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions The buyer gets a stepped-up basis in the underlying assets and larger depreciation and amortization deductions going forward.
To qualify under Section 338, the buyer must make a qualified stock purchase: at least 80% of total voting power and total value within a 12-month window. The election must be filed by the 15th day of the ninth month after the month of the acquisition date.
Section 338(g) vs. Section 338(h)(10)
The two versions play out very differently. A Section 338(g) election is made by the buyer alone and triggers two layers of tax: gain to the target on the deemed asset sale, plus separate gain to the seller on the actual stock sale. Because of that double tax, 338(g) is rare in domestic deals and shows up mostly when the target is a foreign corporation, where the deemed asset gain may be outside U.S. tax.
Section 338(h)(10) is a joint election by buyer and seller. Only one level of tax applies: the deemed asset sale is treated as occurring while the target is still inside the selling group, and the actual stock sale is effectively ignored. The trade-off is that some of what would have been capital gain becomes ordinary income, particularly on inventory and depreciation recapture. Sellers routinely negotiate a gross-up payment from the buyer to cover the additional tax.
Purchase Price Allocation
Under either election, the purchase price is allocated across the target’s assets using a residual method that divides them into seven classes running from cash to goodwill. Both sides report the allocation on Form 8594, and inconsistent filings invite IRS scrutiny.8Internal Revenue Service. Instructions for Form 8594 The allocation controls the buyer’s future depreciation and amortization, so both sides have incentives to push value toward different classes.
Section 336(e)
Section 336(e) reaches deals that Section 338(h)(10) can’t. Section 338(h)(10) requires a corporate buyer; Section 336(e) works no matter who the buyer is: an individual, a partnership, an LLC, a trust, or a mix.9Office of the Law Revision Counsel. 26 USC 336 – Gain or Loss Recognized on Property Distributed in Complete Liquidation That makes it especially useful for S corporation acquisitions where the sellers are individuals. The selling parent (or all S corporation shareholders) and the target must jointly execute a written election by the due date of the target’s tax return for the year of sale.
Tax-Free Reorganization Under Section 368
A stock acquisition can be entirely tax-free to the selling shareholders if it qualifies as a Type B reorganization under Section 368. The requirements are strict. The buyer must acquire control (at least 80% of voting power and 80% of all other classes of stock) solely in exchange for voting stock of the acquirer or its parent.10Office of the Law Revision Counsel. 26 USC 368 – Definitions Relating to Corporate Reorganizations “Solely” is read literally. Any cash, debt assumption, or other non-stock consideration to target shareholders blows up the entire transaction. Even cash for fractional shares or to buy out dissenters can count as disqualifying boot.
Two judicial doctrines apply on top of the statute. Continuity of interest requires the target’s former shareholders to keep a meaningful equity stake in the combined company; a pure voting-stock Type B satisfies this automatically.11eCFR. 26 CFR 1.368-1 – Purpose and Scope of Exception of Reorganization Exchanges Continuity of business enterprise requires the acquirer to keep running the target’s historical business or use a significant portion of its assets in a business. Buying a company and immediately winding it down retroactively disqualifies the tax-free treatment.
When both tests are met, the selling shareholders recognize no gain and carry their old basis into the acquirer’s stock. The acquirer takes a carryover basis in the target stock. No tax is owed on either side until the former target shareholders eventually sell what they received. Both corporations file statements with their returns, and any shareholder who held at least 5% of the target (or 1% for non-publicly-traded targets) must file a separate disclosure identifying the reorganization and the basis and fair market value of the stock exchanged.12GovInfo. 26 CFR 1.368-3 – Records to Be Kept and Information to Be Filed With Returns
Installment Sales
When the buyer pays over multiple years, the seller can often defer gain under Section 453. Gain is recognized in proportion to each payment received, using the gross profit ratio (total gain divided by total contract price).13Office of the Law Revision Counsel. 26 USC 453 – Installment Method
One boundary matters: installment treatment is not available for stock traded on an established securities market. All payments for publicly traded stock are treated as received in the year of sale, regardless of when the cash arrives. Installment reporting is effectively limited to privately held companies.
Large installment sales carry an interest charge on the deferred tax. If a seller’s outstanding installment obligations arising in a single year exceed $5 million in face amount, the seller owes interest to the IRS on the deferred liability.14Office of the Law Revision Counsel. 26 USC 453A – Special Rules for Nondealers A seller who would rather pay all the tax up front can elect out of the installment method on the return for the year of sale.
Qualified Small Business Stock Under Section 1202
Sellers of qualifying small business stock can exclude a large share of their gain, sometimes all of it. Under Section 1202, stock acquired after September 27, 2010, and held at least five years qualifies for a 100% exclusion of capital gain.15Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock
To qualify, the issuer must be a domestic C corporation whose aggregate gross assets did not exceed $50 million at the time the stock was issued. For stock issued after July 4, 2025, the One Big Beautiful Bill Act raised that ceiling to $75 million, with inflation adjustments starting in 2027. The corporation must be engaged in an active trade or business, excluding fields like financial services, hospitality, and professional services where the principal asset is the reputation of employees.
The excludable gain per issuer is capped at the greater of $10 million or ten times the shareholder’s adjusted basis in the stock. For stock issued after the OBBBA’s effective date, the dollar cap rises to $15 million. Sellers who miss the five-year holding period but have held stock more than six months can still defer gain under Section 1045 by reinvesting the proceeds in replacement qualifying small business stock within 60 days.
Section 382 Limits on the Target’s Losses
A target’s net operating loss carryforwards and tax credits can look like a bonus asset, but Section 382 sharply limits how quickly they can be used after an ownership change. The section is triggered when one or more 5% shareholders increase their combined ownership of the target by more than 50 percentage points over any three-year testing period.16Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change Most outright acquisitions clear that threshold immediately.
Once triggered, the annual cap on pre-change losses equals the target’s equity value immediately before the ownership change multiplied by the federal long-term tax-exempt rate. As of early 2026 that rate is 3.58%, so a $20 million target produces an annual cap around $716,000, no matter how large the loss carryforward is. Unused losses that don’t fit within the carryforward period expire.
Section 383 applies the same annual cap to unused general business credits and foreign tax credits.17Office of the Law Revision Counsel. 26 USC 383 – Special Limitations on Certain Excess Credits, Etc. There is also a wipeout: if the new owner fails to continue the target’s business enterprise for the two years after the ownership change, the annual limitation drops to zero and the carryforwards effectively disappear. Buying a company primarily for its losses and then shutting it down produces no tax benefit.
Golden Parachute Limits Under Section 280G
When change-in-control provisions in executive contracts pay out on closing, Section 280G can limit the buyer’s deduction. If compensation paid to a key executive contingent on the change of control equals or exceeds three times that person’s average annual compensation over the prior five years, the excess above the base amount is treated as an excess parachute payment, and the acquiring corporation cannot deduct it.18Office of the Law Revision Counsel. 26 USC 280G – Golden Parachute Payments The executive also owes a 20% excise tax on the excess. Combined, the two costs are frequently large enough to influence deal structure.
FIRPTA Withholding When the Seller Is Foreign
If the seller is a foreign person and the target qualifies as a U.S. real property holding corporation, the buyer must withhold 15% of the total amount realized and send it to the IRS.19Internal Revenue Service. FIRPTA Withholding A U.S. real property holding corporation is one whose U.S. real property interests are worth at least 50% of the combined value of its real property and business assets.
The buyer files Form 8288 and Form 8288-A within 20 days of closing, reporting the withholding and identifying both parties.20Internal Revenue Service. Reporting and Paying Tax on U.S. Real Property Interests The seller can then file a U.S. return to recover any excess. A seller who expects the withholding to overshoot the actual tax can apply for a withholding certificate to reduce it, but the application has to be submitted on or before the disposition date. A buyer who skips withholding can be personally liable for the tax, so this is not an obligation to leave to closing-day cleanup.