State effect of sec. 338(h) (10) election.

• Author: Bergman, Gregory A.

Unlike the temporary regulation it replaces, final Regs. Sec. 1.338(h)(10)-1 makes the Sec. 338(h)(10) election available even if the selling affiliated group does not file a consolidated return. Taxpayers may elect to apply the new rule retroactively to transactions occurring on or after Jan. 14, 1992. The adoption of this regulation may change the position taken by some states that previously have not recognized the Federal tax consequences of a Sec. 338(h)(10) election. A change in a state's treatment of the Sec. 338(h)(10) election could have an effect on previously filed and future tax returns.

Final Regs. Sec. 1.338(h)(10)-1(a) provides:

A section 338(h)(10) election may be made for target only if it is a member of a selling consolidated group, a member of a selling affiliated group filing separate returns, or an S corporation. (Emphasis added.)

This language could lead to a change in analysis by some state revenue departments that previously have not recognized the Sec. 338(h)(10) election with respect to their state income tax statutes.

In recent years, several states that require corporations to file separate returns have taken the position (formally or informally) that they generally do not recognize the Federal tax consequences of a Sec. 338(h)(10) election. In at least some of these states, the basis for this position has been that the states require corporations to compute taxable income on a separate-company basis, while the temporary regulation permitted the election only to selling groups filing consolidated returns.

Thus, the extension of the Sec. 338(h)(10) election to selling affiliated groups...