How to Structure the Sale of Your Software Company to Minimize Taxes

For software founders, selling a company is often the most significant liquidity event of their careers. But while valuation and deal terms dominate early conversations, the structure of the sale can have an equally profound impact — especially when it comes to taxes. A poorly structured deal can erode millions in value through unnecessary tax exposure. A well-structured one can preserve wealth, optimize proceeds, and even create opportunities for future upside.

This article outlines key tax considerations and structuring strategies for software company exits, drawing on insights from real-world transactions and the advisory experience of firms like iMerge, which specializes in software and technology M&A.

Asset Sale vs. Stock Sale: The Foundational Decision

The first — and often most consequential — tax decision in a software company sale is whether to structure the transaction as an asset sale or a stock sale.

• Asset Sale: The buyer purchases individual assets (e.g., codebase, customer contracts, IP) and assumes selected liabilities. This structure is common in lower middle-market deals and is often preferred by buyers for its flexibility and tax benefits.
• Stock Sale: The buyer acquires the equity of the company, taking ownership of all assets and liabilities. This is generally more favorable for sellers, especially from a tax perspective.

From a tax standpoint, founders typically prefer stock sales because the proceeds are taxed at long-term capital gains rates (currently 20% federally, plus 3.8% Net Investment Income Tax, and applicable state taxes). In contrast, asset sales can trigger double taxation for C-corporations — once at the corporate level and again when proceeds are distributed to shareholders.

For pass-through entities (e.g., LLCs or S-corps), asset sales may still result in higher taxes due to depreciation recapture and ordinary income treatment on certain assets.

Entity Type Matters: C-Corp vs. S-Corp vs. LLC

Your company’s legal structure plays a critical role in how sale proceeds are taxed. Here’s how it typically breaks down:

• C-Corporation: Asset sales can be punitive due to double taxation. Stock sales are more tax-efficient, and if the company qualifies under IRC Section 1202, founders may be eligible for the Qualified Small Business Stock (QSBS) exclusion — potentially eliminating up to $10 million in capital gains per founder.
• S-Corporation: Avoids double taxation, but asset sales can still result in ordinary income on certain components. Stock sales are cleaner, but buyers may push for asset deals due to liability concerns.
• LLC (Taxed as Partnership): Asset sales are the default and can be tax-inefficient for sellers. However, LLCs offer flexibility in allocating gains and losses among members.

Founders should evaluate whether a corporate restructuring (e.g., converting to a C-corp to qualify for QSBS) is viable well in advance of a sale. Note that QSBS eligibility requires a five-year holding period and other criteria — timing is critical.

Leveraging QSBS: A Powerful but Underutilized Tool

One of the most powerful tax planning tools for software founders is the Qualified Small Business Stock (QSBS) exclusion under Section 1202 of the Internal Revenue Code. If your company qualifies, you may be able to exclude up to 100% of capital gains (up to $10 million or 10x your basis) from federal taxes.

To qualify:

• The company must be a domestic C-corp
• Gross assets must not have exceeded $50 million at the time of stock issuance
• The company must be engaged in a qualified trade or business (most software companies qualify)
• The stock must be held for at least five years

QSBS planning should begin years before a sale. If you’re within the five-year window, consider deferring the sale or exploring tax deferral strategies like installment sales or equity rollovers.

Installment Sales and Earn-Outs: Timing Matters

Another way to manage tax exposure is by spreading income over multiple years. Installment sales — where a portion of the purchase price is paid over time — can defer tax liability and potentially keep the seller in a lower tax bracket.

However, installment treatment is not available for stock sales of publicly traded companies or for sales of inventory or receivables. Additionally, earn-outs — which are common in software M&A — may be taxed as ordinary income depending on how they’re structured. Careful drafting of earn-out provisions is essential to avoid unexpected tax treatment.

For more on this, see How Do I Handle Earn-Outs in the Sale of My Software Business?

Equity Rollovers: Deferring Taxes with a Second Bite

In private equity-backed deals, founders are often asked to “roll over” a portion of their equity into the new entity. This can be a tax-efficient way to defer gains and participate in future upside — the so-called “second bite at the apple.”

To qualify for tax deferral under IRC Section 351 or 721, the rollover must be structured properly. Founders should work closely with tax counsel and M&A advisors to ensure compliance and alignment with their long-term goals.

State Taxes and Residency Planning

Federal taxes are only part of the equation. State tax rates vary widely — from 0% in states like Texas and Florida to over 13% in California. If you’re considering a move to a low-tax state before a liquidity event, timing and documentation are critical. States like California aggressively challenge residency changes if they occur too close to a sale.

Residency planning should begin at least 12–18 months before a transaction and include clear evidence of intent (e.g., home purchase, voter registration, driver’s license, business relocation).

Pre-Sale Planning: The Earlier, the Better

Tax optimization is not something to address after signing a Letter of Intent. Ideally, founders should begin planning 12–24 months before a potential exit. This allows time to:

• Restructure the entity if needed (e.g., convert to C-corp for QSBS)
• Clean up the cap table and ensure proper stock documentation
• Evaluate estate planning strategies (e.g., gifting shares to family trusts)
• Model different deal structures and their tax implications

As we noted in Exit Business Planning Strategy, early alignment between legal, tax, and M&A advisors can significantly increase after-tax proceeds and reduce deal friction.

Partnering with the Right M&A Advisor

Tax structuring is deeply intertwined with deal negotiation. A seasoned M&A advisor — particularly one with experience in software and SaaS transactions — can help position your company for a tax-efficient exit while maximizing valuation and deal terms.

Firms like iMerge work closely with founders, tax counsel, and transaction attorneys to model different scenarios, negotiate favorable structures, and ensure that tax considerations are integrated into every stage of the process — from buyer targeting to LOI to closing.

Conclusion

Minimizing taxes in the sale of a software company requires more than just good accounting — it demands strategic foresight, careful structuring, and the right team of advisors. Whether it’s leveraging QSBS, negotiating a stock sale, or planning an equity rollover, the decisions you make before and during the sale process can have lasting financial consequences.

Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.