You Got a Term Sheet. Here Are Tax Questions That May Be Worth Asking Before the Deal Gets Too Far Along.

A signed letter of intent tends to start a clock on a handful of tax questions that are often easier to handle in the first two weeks than in the last two. This is a list of the questions, not the answers; the answers belong to your tax advisor, and the sooner they are asked, the more options may still be open.

A letter of intent is a negotiating document. In our experience, it is also the moment a set of tax questions starts to matter, and most of them seem to get harder to answer well the closer the deal gets to closing.

A note on scope before anything else: CGL does not provide tax advice. What follows is a list of questions we have seen come up after a term sheet is signed, described at a high level so that you can put them in front of your tax advisor early. The answers depend entirely on your facts, and each of the rules below has exceptions and thresholds this article does not cover.

Question 1: Could anyone’s payout trigger the golden parachute rules?

Section 280G of the tax code is, in our experience, among the rules most often missed in lower middle market deals, in part because S corporations (and other corporations eligible to elect S status) are generally exempt from it and many owners have never encountered it. It can apply when a change in control triggers payments to certain officers, shareholders, or highly paid employees, including the value attributable to accelerated vesting, transaction bonuses, severance, and retention pay, whose combined value equals or exceeds three times the individual’s average compensation over the prior five years. If it does, the company may lose its deduction for the excess and the individual may owe a 20 percent excise tax on top of ordinary income tax. The cliff can be sharp: a payout just under the line may owe nothing extra, and one just over it may be taxed on everything above the base amount.

For companies whose stock is not readily tradeable on an established securities market, an exemption may be available: shareholder approval by more than 75 percent of the voting power, after adequate disclosure, with the affected individuals’ shares excluded from the count. In practice, we understand the individuals typically first waive their right to the excess payments and the vote then decides whether they receive them, which is why the process is usually set up well before closing and can add time and uncertainty if it starts late. A founder whose historical salary was modest and whose equity accelerates at closing may hit three times the base amount more easily than expected.

Question 2: Is the deal an asset sale or a stock sale, and does it matter to you?

Buyers often prefer to buy assets, because they may get a stepped-up tax basis and larger future deductions. Sellers of C corporations often prefer to sell stock, because an asset sale by a C corporation is generally taxed twice, once at the corporate level and again when the proceeds come out. For S corporations, the parties sometimes split the difference: a Section 338(h)(10) or 336(e) election, or an “F reorganization” done before closing, may give the buyer asset treatment while the seller sells equity. (An LLC taxed as a partnership generally gives the buyer asset treatment without an election.) Each of those structures has requirements (an 80 percent purchase and, for a 338(h)(10) election, a corporate buyer; for an F reorganization, a properly timed QSub election) and potential consequences for the seller (some of the gain may be ordinary income rather than capital gain; an F reorganization is also commonly described as letting the buyer keep the company’s tax ID and protecting the step-up if the S election was ever defective). Private equity buyers commonly request the F reorganization. The question for your advisor is what the requested structure may do to your after-tax number, not just the buyer’s.

Question 3: Is the earnout purchase price or compensation?

If part of the price is contingent, two tax questions may follow. First, deferred purchase price may be eligible for installment reporting, so tax is paid as payments arrive, though depreciation recapture generally has to be recognized in the year of sale and an interest charge can apply when deferred obligations exceed $5 million. Second, if the earnout is tied to the seller’s continued employment, the IRS may treat it as compensation, taxed as ordinary income and subject to withholding, rather than as capital gain. The withholding regulations state that “the name by which the remuneration for services is designated is immaterial.” Whether all owners’ earnouts are reduced on any owner’s departure, or only the key employees’, may change the analysis.

Question 4: Is the rollover equity actually tax-deferred?

Rollover equity is often described as tax-free. Sometimes it may be. Contributing shares or assets to the buyer’s entity in exchange for equity can qualify for nonrecognition under Section 351 (corporations) or Section 721 (partnerships and LLCs), but only if the structure fits the rules: Section 351 generally requires the contributing group to control 80 percent of the corporation immediately afterward, which founders rarely do on their own, and cash received alongside the equity is generally taxable (to the extent of gain) up to the amount of the cash. If the deal is not planned this way from the start, a seller could end up owing tax on equity that cannot be sold to pay it. Whether rolled shares keep any qualified small business stock status is a separate question with its own limits.

Question 5: Could QSBS timing change anything?

Section 1202, which we covered in an earlier edition, may exclude a large amount of gain from federal tax if the stock and the company qualify and the holding period is met. If a sale would come before the holding period is satisfied, Section 1045 may allow a seller who has held qualifying stock for more than six months to roll the gain into new qualifying stock purchased within 60 days of the sale. The 60-day window does not appear to be extendable, and how the rollover interacts with the 2025 amendments to Section 1202 is a question practitioners appear still to be working through. It may be worth raising with your advisor before, not after, the closing date is set.

Question 6: Where will you be a resident when the gain is recognized?

State tax on a sale is generally set by residency, and residency is a facts-and-circumstances test that tends to look at where your home, family, licenses, doctors, and days are, not at where you filed a change-of-address form. California’s top marginal rate is 13.3 percent (12.3 percent plus a 1 percent surtax on taxable income over $1 million). Washington taxes long-term capital gains at 7 percent above a standard deduction, plus an additional 2.9 percent on gains over $1 million, and has enacted a separate 9.9 percent tax on income over $1 million scheduled to take effect in 2028, which is subject to a repeal initiative on the November 3 ballot and to pending constitutional litigation. Eight states have no individual income tax at all. If a move is under consideration for any reason, its timing relative to the sale is a question to raise with your tax advisor early; tax authorities in high-tax states are understood to examine that timing closely. It is often also a question for an advisor in the state you would be moving to.

Question 7: What happens to the option holders?

Cashing out options at closing can have withholding consequences that differ by option type and that the company, as employer, is generally responsible for getting right. Cash-outs are generally treated as compensation income subject to income and employment tax withholding, typically withheld at the optional 22 percent flat supplemental rate and at a mandatory 37 percent on amounts above $1 million in a year. If part of the option proceeds is held in escrow or tied to an earnout, Section 409A has timing rules that generally permit payment on the same schedule as the shareholders, within five years. A plan drafted with a sale in mind may give the company flexibility; one that was not may need amendments before closing.

Why this may matter now

Three of the seven questions (280G, structure, and rollover) are generally far easier to address before the purchase agreement is final, with the 280G vote itself typically run before closing, and one (residency) turns on facts that are set long before that. The 2025 federal tax law also appears to have changed the math buyers are doing: full expensing of qualifying property and an EBITDA-based interest deduction limit were restored and made permanent, and domestic research costs are deductible again, all of which may affect what a buyer will pay for a stepped-up basis and therefore how hard it pushes for asset treatment.

What to bring to your tax advisor

• The term sheet, the cap table, and every employment, bonus, and equity agreement for anyone who might be a “disqualified individual”
• The proposed structure (asset, stock, election, or F reorganization) and any rollover terms
• The earnout mechanics and whether any of it is tied to employment
• The company’s QSBS analysis, if one has been done, and the holding period for each block of stock
• Your residency facts, if a move is contemplated

This article is a general description of tax rules as of October 29, 2026 and omits thresholds, exceptions, and state variations that can change the answer. It is not tax advice. CGL does not provide tax advice, and nothing here should be relied on without consulting a qualified tax advisor about your specific situation.

How CGL can help

CGL handles the legal structuring and negotiation of sales for founders and owners and works alongside clients’ tax advisors so that the structure questions above can be raised at the letter of intent, when they may still be negotiable.

If you have a term sheet in hand, reply with the word “closing” and we will send you the one-page list of questions we suggest sellers bring to their first meeting with their tax advisor. Just the one word is enough; we will follow up.

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This newsletter is provided by CGL LLP for general informational purposes only and is not legal or tax advice; reading it or replying to it does not create an attorney-client relationship. The information is current as of October 29, 2026 and may change. Please consult counsel about your specific situation.

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