Understanding sec. 338 and 338(h) (10) elections.

• Author: Koppel, Michael D.
• Position: IRC section 338

As a general rule, buyers prefer to purchase the assets of a corporate business. One of the principal nontax reasons for buying assets (as opposed to the stock) of a target corporation (T) is that a purchaser (P) can exclude pre-acquisition liabilities from the purchase, and generally acquire only those assets (and liabilities) it deems appropriate for its business. From a tax perspective, P will want to buy the assets of a corporation because, under Sec. 1012, it will obtain a cost basis (usually a basis step-up) for the acquired assets. A basis step-up is also desirable to P, as it allows P to take increased depreciation and amortization deductions for the acquired assets. Sellers, on the other hand, usually prefer to sell stock, rather than assets; on transferring the stock to a buyer, all of T's liabilities (including contingent liabilities) will pass to the buyer. From a tax perspective, individual owners of a C corporation prefer a stock sale over an asset sale, because it produces only one level of tax (shareholder), not two (corporation and shareholder).

Is there a way for the parties to reconcile these divergent positions? An acquisition transaction can be structured as a stock sale, while still giving P the option to obtain a basis step-up in the acquired assets. The Code contains two elections to achieve this objective, the availability of which depends on whether T is a C corporation, an S corporation or a subsidiary of another corporation. If T is a C corporation, a Sec. 338 election is available; if T is an S corporation or a subsidiary of another corporation, a Sec. 338(h)(10) election is available. A Sec. 338 election is not usually made because of the added cost to the buyer. By contrast, the Sec. 338(h)(10) election is common, because the desired tax benefits can usually be obtained with minimal or no added cost to either the buyer or seller.

Sec. 338 Election

A corporate buyer of C corporation stock may, if it meets certain requirements, make a Sec. 338 election. If made, T is treated as having sold all of its assets on the acquisition date for fair market value (FMV) to a new corporation (new T), and thereafter immediately liquidated (Sec. 338(a)(1)). T recognizes gain or loss on the "deemed sale" just as if T had sold its assets to E The deemed sale is treated as occurring after T's stock has been sold, and is included in a one-day deemed-sale return that P must file as owner of new T; see Sec. 338(h)(9) and Temp. Regs...