Transaction pursuant to qualified stock purchase treated as distribution in liquidation.

• Author: Borkes, Jason

Business combinations can occur in the form of asset acquisitions or stock acquisitions. From a buyer s perspective, there are many tax advantages to structuring a business combination transaction as an asset acquisition. Conversely, from a seller's perspective, the tax advantages are greater when the transaction is structured as a stock acquisition. For the potentially substantial tax benefits, buyers will frequently pay a premium to structure a business acquisition transaction as an asset acquisition. Another way to structure a business combination transaction is as a hybrid between an asset acquisition and a stock acquisition, through a qualified stock purchase with a Sec. 338 election.

Sec. 338

In a stock acquisition transaction, if the acquisition is a qualified stock purchase and an election is made under Sec. 338, the stock acquisition is treated as an asset acquisition for tax purposes. Under this scenario, the buyer will have the privilege of a step-up in basis of the seller's assets. At the closing of the transaction, the seller's assets will be revalued and stepped up to fair market value (FMV) on the buyer's balance sheet, which will closely reflect the purchase price. The buyer allocates any amount of the purchase price that exceeds the FMV of the asset acquired to goodwill on its balance sheet.

Under the Sec. 338 election, the parties treat the transaction as a stock sale for legal purposes, so the buyer will still acquire the seller's liabilities and stock, in addition to its assets. The asset sale generates taxable gain to the seller. Often, the parties will structure the transaction so that the buyer bears the burden of paying tax on the gain. The gain will be an adjustment on Schedule M-1 of the corporate return, since it is a tax-only item under the election. To make a Sec. 338 election, the buyer must execute a qualified stock purchase, which is a transaction or series of transactions in which a buyer purchases at least 80% of the total voting power and value of the seller's stock within 12 consecutive months after the initial purchase of the stock (Sec. 338(d)(3)).

Tax Benefits

Under an asset acquisition, the foremost tax benefit to the buyer is the step-up in basis of the assets acquired. Should the buyer sell the acquired assets in the future, it will recognize less gain, and thus its tax liability will be lower, since the assets will have been revalued up to their FMV.

A second tax benefit to the buyer of a step-up...