New regs. alter tax consequences of sec. 338(h) (10) elections.

• Author: O'Connell, Frank J., Jr.

Earlier this year, the IRS issued temporary regulations under Sec. 338, effective for transactions after Jan. 5, 2000. The prior regulations largely were restatements of the temporary regulations, developed and repeatedly amended over several years. As a result of the haphazard manner in the promulgation of these regulations, they were difficult to follow, lacked clear guidance on purchase price allocations and were inconsistent in their use of general tax accounting principles versus those used outside the purview of Sec. 338.

The new regulations modify the rules that determine a seller's amount realized when making a Sec. 338(h)(10) election. In addition, the repeal of the installment sale method for accrual-basis taxpayers also affects the tax consequences of such elections.

Amount Realized and Basis--Prior Regs.

Under prior Regs. Sec. 1.338(h)(10)-1(f), the modified aggregate deemed sales price (MADSP) was the price at which an old target was deemed to sells its assets if it made a Sec. 338(h)(10) election. The MADSP is the sum of the following items:

1. The grossed-up basis of the purchasing corporation's recently purchased stock;

2. The new target's liabilities as of the beginning of the day after the acquisition date (i.e., the old target's liabilities deemed transferred to the new target); and

3. Other relevant items (i.e., reduction for purchaser's costs included in the first item and seller's expenses).

The amounts in the first and third items do not directly depend on any overall accounting method. The grossed-up basis of the purchasing corporation's recently purchased stock depends directly on the purchaser's basis of the newly acquired stock. Other relevant items simply include the purchaser's acquisition costs (included in the basis of the newly acquired target stock) and the seller's expenses incurred in connection with the sale of the target's stock. The liabilities considered in determining MADSP are the same liabilities that the new target considers in determining the basis of assets acquired in the deemed purchase.

Under Regs. Sec. 1.338(h)(10)-1 (e)(5), the basis of new target's assets is known as the adjusted grossed-up basis (AGUB), determined under Regs. Sec. 1.338(b)-1(c). The AGUB is the sum of the exact same three items that comprise the MADSP. However, AGUB is not reduced by the purchaser's acquisition costs, nor the seller's expenses incurred in connection with the sale of the target's stock.

Under Regs. Sec...