Asset acquisition: practical guidance on Sec. 338 election.

• Author: Barragato, Charles A.
• Position: PROFESSIONAL ISSUES

The final regulations under Internal Revenue Code Sec. 338 certainly provide much desired clarity and guidance to tax practitioners. The main goal of these regulations was to change several accounting rules relating to deemed and actual asset acquisitions to enable them to be treated more in line with general principles under the tax law.

These Final Regulations have been in place for more than three years since they are to be applied to all qualified stock purchases or applicable asset acquisitions made after March 15, 2001.

A QSP is defined as a stock acquisition wherein the purchasing corporation acquires 80 percent or more of the total voting power and 80 percent or more of the total value of the stock of a target corporation by purchase within a 12-month period.

Sec. 332 provides for the liquidation of a controlled subsidiary corporation. This definition also is used for purposes of applying Sec. 338.

TYPES OF ELECTIONS

There are still two different types of elections which can be made pursuant to Sec. 338:

Election 1: Often referred to as the general election under Sec. 338(g), this election takes a traditional view of the tax consequences on the purchasing corporation, target corporation and the selling shareholders.

In essence, the selling stockholders continue to be taxed on the sale of their stock. The target corporation is viewed as having transferred all of its assets to an unrelated person in exchange for consideration which includes the assumption of liabilities thereby generating a realized gain or realized loss on the deemed sale of assets.

In accordance with the provisions of Sec. 338(g), the new target corporation is treated as a new corporate entity that is not related to the old target except for issues relating to retirement plans and similar provisions. [Regs 1.338-1(b)(2)].

Election 2: A more novel approach to the contemplated transaction is electing Sec. 338(h)(10), whereby the selling shareholders are permitted to join with the purchasing corporation in choosing to significantly alter the tax ramifications for the selling shareholders, the target company, and the purchasing corporation.

Although this election has received much attention as a planning tool during the past few years, tax practitioners should not automatically assume that it is the best choice in all situations. The following example will illustrate the care that must be taken to make an election that is most advantageous for clients.

EXAMPLE

Assume...