The Acquisition Process
When businesses acting as the seller or purchaser are going through the acquisition process, there is likely to be discussion as to whether the acquisition will be structured as an asset purchase or a stock purchase. There are advantages and disadvantages to an asset purchase and a stock purchase for both the seller and purchaser.
However, there may be a means to treat a stock purchase as an asset purchase and receive the best of both worlds. The article below has been prepared by a Denver tax attorney and Denver business attorney to discuss certain tax matters. Still, please always discuss your specific issues with your attorney and check for current laws and regulations that may have changed.
A Stock Purchase
A stock purchase is relatively simple as the seller or target corporation’s stock is purchased. The buyer obtains control of the target corporation’s assets with no other action by owning all of the stock. This being said, the buyer may also inherit liabilities of the target corporation as the business continues and is exposed to prior matters. An asset purchase transaction may be more complex in that the buyer is purchasing the assets and not the stock, thus requiring the transfer of title to each asset, which depending upon the facts and circumstances, could begin to amount to significant time and cost etc. Further, if the target corporation has special licenses and permits, these may not be transferable to the buyer and could create additional issues under an asset purchase.
An Asset Purchase
As it is good and bad with both structures, a buyer, from a tax perspective, will generally prefer an asset purchase because the buyer, after the asset purchase, can step up the basis in purchasing assets. Therefore, the asset’s stepped-up basis will lead to more significant depreciation to lessen taxable income and thus tax at the corporate or personal level. In comparison, when the stock is purchased, the buyer will receive a basis in the stock at the purchase amount. The realization of the tax benefit may not come until the buyer sells the stock using the basis in the stock to offset a capital gain. Thus, the buyer will likely not “realize” the tax benefit of the stock purchase until a later date than they would under an asset purchase agreement.
There is a means under Internal Revenue Code Section 338 for the buyer to make an election treating a qualifying stock purchase as an asset purchase for federal income tax purposes. Under 338, if the transaction qualifies and the election is made, the transaction is treated as if the buyer purchased the target corporation’s assets for the purchase price of the stock. Therefore, the buyer will receive a more advantageous step-up based on the assets.
Section 338 Election
The buyer acquires the seller’s stock at a discount in a stock acquisition transaction. Suppose the buyer makes a qualifying stock purchase within 60 days of the date of transfer. In that case, it must elect to treat the transaction as an asset acquisition for federal income tax purposes. This is known as a “step-up” election.
If the buyer makes a Sec. 338 election, it treats the transaction as a stock purchase for legal purposes. Hence, it continues to acquire the seller’s liabilities, including outstanding debt, shares of capital stock, and certain contingent obligations. However, the buyer does not acquire the seller’s assets. Instead, it steps up the basis of those assets to the purchase price paid for the stock. At the end of the period, the buyer reports the transaction as a sale of stock and recognizes ordinary income equal to the difference between the purchase price and the adjusted cost basis of the stock.
The buyer can choose to allocate the excess of the purchase price over the adjusted cost basis to goodwill. Goodwill represents the purchased excess over the adjusted cost basis of intangible assets such as customer relationships, brand recognition, and patents.
Making the 338 elections is a means to structure an acquisition as a stock sale, which may have benefits, but allow the buyer the tax advantage of an asset purchase agreement. John McGuire, a Denver tax attorney and Denver business attorney at The McGuire Law Firm, has prepared this article.