What is a 338 Election? How would I use it when I sell my business?

In a typical acquisition (using an S-corporation as an example), the seller seeks to maximize capital gains, on which they pay a lower tax rate, and the buyer seeks to maximize the present value of tax deductions. While this may be desired, there may be a need to effect the transaction as a stock deal rather than an asset deal.

A Section 338 is used when parties to the acquisition would like the tax treatment of an asset deal, but the legal structure of a stock deal. This tax treatment is predominantly related to the ability for a buyer to step up the tax basis of assets to fair market value (FMV), as opposed to a typical stock deal, which is on a carryover basis. In turn, this can have a significant positive effect on the purchase price for the seller.

If an acquisition is completed as a Section 338 election, then the target corporation is treated for tax purposes as if it has sold all of its assets at the close of the acquisition date at fair market value in a single transaction, and is treated as a new corporation with no tax history that purchased all of the assets as of the beginning of the day after the acquisition date. The depreciation and amortization of all asset write-ups and intangibles, including goodwill in the purchase price allocation becomes a tax-deductible expense.

Within Section 338, there are two types of Section 338 election: (g) and (h)(10); where Section 338 (h)(10) is the most common, because it results in a single level of tax, and NOLs/tax attributes can offset any taxable gain on the deemed sale.

Before we go too far in trying to oversimplify a tax rule, we would recommend that you have a tax professional study the implications for your particular business, but at least this may get it on your radar. If you’re interested, you can look up the IRS ruling at the Tax Almanac, a free online resource.

As with all tax codes there are a number of qualifying factors for these elections, which include the need for both parties to be corporations, where the Buyer must be a C-corporation and make a Qualified Stock Purchase (“QSP”). As a result, individuals and partnerships cannot make a 338 election, as they can’t make a QSP, unless they circumvent this restriction by forming a new corporation (“NewCo”) to acquire the Company’s stock.

Note: ClearRidge does not provide tax or legal advice.