Basics of 338(h)(10) Elections
By Section 338(h)(10) allows a buyer and seller in a qualified stock purchase to elect jointly for the sale of target stock to be treated for tax purposes as a sale of the target’s assets. That is beneficial to the buyer because the transaction is a stock sale for state law purposes (which avoids the need to transfer legal title to assets and the shifting of employees to a new entity) while obtaining a depreciable or amortizable cost basis in the underlying assets. That allows the buyer to depreciate the purchase price over time. The seller often does not prefer a 338(h)(10) election compared to a regular stock sale because the election may result in additional taxes to the seller compared to a regular stock sale. As a result, sometimes the seller will agree to the 338(h)(10) election in exchange for an upward adjustment in the purchase price paid by buyer. Because a 338(h)(10) election is a joint election requiring the consent of both buyer and seller, it cannot be made unless the parties agree.
Only corporation buyers (both S corporations and C corporations) are eligible to make a 338(h)(10) election (but a similar election under Section 336(e) is sometimes available where the buyer is not a corporation). For a 338(h)(10) election to be available, the target must be either an S corporation or a member (but not the parent) of an affiliated group of corporations. The election requires a qualified stock purchase, which is the acquisition of at least 80% of the target’s stock.
When a 338(h)(10) election is made, the target is deemed to sell all of its assets to a new hypothetical target and to distribute the proceeds of the fictional sale to the shareholders of the target immediately before the original target ceases to exist. However, all of those steps are deemed to happen only for tax purposes. For state law purposes, the original target remains the entity acquired.
John G. Hodnette is a partner with Fox Rothschild, LLP in Charlotte.