Application of Sec. 338 to S corporations.

• Author: Starr, Samuel P.
• Position: Brief Article

Final regulations under Sec. 338 provide new rules for S corporations. In a significant liberalization, the final regulations permit a Sec. 338(h)(10) election for a target S corporation. The target S corporation recognizes gain or loss as if it sold all of its assets at the close of the acquisition date. The S shareholders take the deemed sale gain into account under normal S rules. The S shareholders, however, do not recognize gain or loss on the S stock sale. Thus, by making a Sec. 338(h)(10) election, the basis of the S corporation's assets can be stepped up with only a single level of tax.

In contrast, a regular Sec. 338 election for an acquired S corporation will result in two levels of tax. Gain or loss will be recognized on a C corporation return for the deemed asset sale and gain or loss will be recognized by the shareholders on the saLe of the S stock.

The final regulations provide no additional guidance as to whether an acquiring S corporation can make a Sec.338 election. The Service's ruling position, however, permits the election; see IRS Letter Rulings (TAMs) 9325006 and 9245004.

The regulations are generally effective Jan. 20, 1994, the scheduled date of publication in the Federal Register. However, target corporations can...