The PE Deal Series · Post D.19
View the full series →The Tax Traps Hiding in Your Deal
You can owe tax at closing on money you won't collect for years — and a default won't unwind it.
Every founder models the upside of a deal. Revenue multiples, earnout projections, rollover returns. The spreadsheets answer one question: how much will I make?
Almost nobody models the tax bill.
Here's the part that surprises founders. Your tax bill doesn't wait for your cash. In the wrong structure, you can owe the IRS at closing on money you won't collect for years — or ever. That's not a theoretical risk. It's the architecture of the Crossfield deal.
The Tax Bill That Arrives Before the Money
Imagine your employer hands you a $500K bonus — payable $100K a year for five years. Fair enough. Then a tax bill shows up in April for the whole $500K. All of it. Now. You've collected $100K and you owe as if you pocketed five times that.
No employer runs payroll this way. Some deal structures do exactly this.
When a sale is taxed as a deemed asset sale, parts of the tax are calculated the day the deal closes — including on price still sitting in notes and earnouts. The founder owes now on money that exists in a contract, not yet in a bank account.
The Crossfield Tax Traps
The Crossfield transaction created three tax exposures the founders didn't model at signing.
Tax due before the cash. Crossfield was structured as a 338(h)(10) election — a deemed asset sale for tax purposes. James and Dan were taxed as if the company sold its assets. Part of that gain is depreciation recapture, taxed at ordinary income rates — and recapture can't be spread out over the note payments. It's due for the year of closing. Most of their price was deferred in seller notes and an earnout. The recapture tax wasn't. They owed the IRS at closing on money they hadn't collected.
A default won't unwind the tax. As note payments come in, the founders report the gain and pay the tax. Suppose Ridgeline later defaults. The deal doesn't reverse. James and Dan don't get the company back, and they don't get a refund on the gain they already reported. What they get is a bad-debt write-off — slow, capped, and worth far less than the tax it's meant to offset. The gain gets taxed on schedule. The loss, when the money disappears, comes back on the worst possible terms.
The allocation worked against them. In a deemed asset sale the price is split across asset classes, and the split decides how much of the founders' gain is taxed as capital gain versus ordinary income. Goodwill is capital gain — the founder's friend. Equipment, depreciation recapture, and anything dressed up as a consulting or non-compete payment is ordinary income — taxed higher. Whitfield & Associates controlled the allocation and steered it away from goodwill. More of the founders' gain landed in the ordinary-income bucket. Higher rate, on the cash they actually received.
Barrett raised this during the negotiation. They asked for a mutual-agreement clause giving the founders input on the allocation. Whitfield rejected it. The final agreement gave Ridgeline sole discretion, subject only to IRS consistency rules that do nothing to protect the seller's tax position.
Three traps. None appeared in the LOI. None came up in the handshake meetings. All three were buried in the definitive agreement and the tax elections filed at closing.
Deal Spectrum: 7/10
The left column shows what a founder-favorable version of this term looks like. The right column shows what Crossfield signed.
The mental model is the Phantom Tax. Your tax bill is set by what the deal says you're owed and when the structure says you're taxed — not by when the cash actually reaches you. When the structure is wrong, the tax shows up early, lands heavy, and doesn't refund itself if the money never comes.
The Crossfield Moment
Dan's accountant called him a few weeks before the first filing deadline. He'd been through the deal documents and the 338(h)(10) paperwork.
"You're going to owe a big check this April," the accountant said.
Dan did the math in his head. "On what? Most of my money is in the notes. I haven't been paid."
"I know," the accountant said. "The tax doesn't wait for the notes."
Founder Protection Tips
Engage your own tax counsel to model the deal before signing. Every structure is taxed differently — model the recapture, the allocation, and the timing on yours, not just the upside. Know what you owe at closing, before the cash shows up.
Negotiate mutual agreement on purchase price allocation. The split between capital gain and ordinary income is decided here. Don't let the buyer control it unilaterally.
Push for the tax to track the cash. Where you can, structure so tax on deferred payments lands as you collect it — or get indemnity for the gap when the structure forces tax ahead of payment.
Model the downside of a default or a discounted payoff. If the notes go bad, or the buyer offers to settle for less, know in advance what it does to tax you've already paid. The write-off rarely makes you whole.
Read before you sign.