Section 338 Election Benefits
Section 338 Election of the Internal Revenue Code provides a way to treat stock purchases as asset acquisitions for tax purposes only. In other words, under Internal Revenue Code §338(h)(10), the selling corporation will bear the tax associated with the transaction, but there will only be one level. This single layer of taxation is based on the inherent gain in the assets held by the entity, but there is no tax on the subsequent stock sale. Section 338 Election of the tax code can help resolve some of the issues created in stock sales to benefit both buyers and sellers. This article has been prepared by a Denver business attorney and tax attorney to discuss the specific problems in greater detail.
Requirements for Section 338(h)(10)
Section 338(h)(10) elections require that both the buyer and the seller be corporations, and both parties must agree to make the election (see §338(a)). Unlike section 338(g), where the purchaser bears the tax burden, the seller pays the tax from the asset sale, so this requires agreement between the corporate parties.
Additionally, 338(h)(10) requires a qualified stock purchase. Section 338(d) defines a qualified stock purchase as one where the transaction occurs within a 12- month acquisition period and also satisfies the elements of §1504(a). Section 1504(a)(2) requires purchasing 80% of the vote and value of the target entity. For purposes of §338(h)(10), the 12- month acquisition period is not limited to a calendar year.
If a 338(h)(10) election has been properly made, the transaction is essentially treated as an asset sale followed by liquidation, with the tax liability flowing to the selling party. Mechanically, the purchasing target corporation is
deemed to create a new target entity. This new entity’s sole purpose is to purchase the assets of the original entity. This allows an asset purchase while maintaining the stock sale characteristics for legal purposes. In other words, the asset sale is only considered for tax purposes, not other legal aspects. Note, the asset sale does trigger gain to the selling corporation, but there is no subsequent tax from the stock sale, thus eliminating the second level of taxable income. Treating the sale as a stock purchase may benefit the purchaser, such as maintaining specific contracts, permits, licenses, and other corporate attributes that could be lost from an asset purchase agreement.
The Tax Perspective
From a tax perspective, the purchasing party is satisfied because the transaction has been treated as an asset sale that provides a stepped-up basis for the assets. The seller is satisfied because there has only been one level of tax from the sale of the assets. This increases depreciation deductions which may be used to offset ordinary income in the future. Additionally, if the selling party has any losses, then depending on the character of the gain, these may be offset by the deemed asset sale.
Overall, §338 transactions provide a way for buyers and sellers to structure a transaction to maximize the benefits of both stock sales and deemed asset sales while reducing tax liabilities to each party. You should discuss the elements and implications of a section 338 transaction with your business attorney or tax attorney.
You can schedule a free consultation with a Denver business attorney or tax attorney by contacting The McGuire Law Firm at 720-833-7705.