Section 338(h)(10) and 336(e) Elections in a Business Sale

A buyer may want the legal simplicity of buying stock and the tax benefits of buying assets. Sections 338(h)(10) and 336(e) can treat a qualifying stock transaction as a deemed asset sale for federal income-tax purposes, giving the target a stepped-up basis in its assets.

The buyer's future deductions usually come at a current tax cost to the seller. The election should therefore be priced, modeled, and negotiated rather than treated as routine closing paperwork.

Why Buyers Request the Election

Without an election, a stock buyer generally takes basis in the acquired stock while the target's inside asset basis remains unchanged. A deemed asset sale allocates purchase price among receivables, inventory, equipment, real estate, identifiable intangibles, and goodwill. The buyer may recover the resulting step-up through cost of goods sold, depreciation, or amortization.

Section 338(h)(10)

A Section 338(h)(10) election is commonly available when a purchasing corporation makes a qualified stock purchase of a target that is an S corporation or a subsidiary in a consolidated or affiliated group. A qualified stock purchase generally requires acquiring at least 80% of vote and value during a 12-month acquisition period.

The buyer and seller make the election jointly. The target is treated as selling its assets and then liquidating for tax purposes, even though the legal transaction is a stock sale. S-corporation shareholders must account for pass-through gain, stock-basis adjustments, and liquidation consequences.

Section 336(e)

Section 336(e) can provide similar deemed-asset treatment for certain qualified stock dispositions, including transactions where the buyer is not a corporation. The election is generally made by the seller and target under the regulations rather than jointly with the buyer.

Eligibility, timing, consistency statements, and documentation differ from Section 338. The election is not a fallback to be added after the return deadline without reviewing the regulatory requirements.

Seller Tax Cost

The deemed asset sale can convert part of what might have been capital gain on stock into ordinary income from receivables, inventory, depreciation recapture, and certain intangibles. State tax can also differ because asset gain may be sourced to operating states.

For an S corporation with built-in gains exposure, the election may create an entity-level tax in addition to shareholder tax. Historical C-corporation periods, asset basis, depreciation, and the Section 1374 recognition period must be reviewed.

Negotiating the Gross-Up

Calculate the seller's after-tax proceeds with and without the election. The requested price increase is not always equal to the full incremental tax because timing, basis recovery, state taxes, and deal certainty matter. Still, the buyer's tax benefit is real economic value and should inform price.

The purchase agreement should allocate control over the election, Form 8883 reporting, asset classes, state elections, tax returns, audits, indemnities, and post-closing cooperation.

Worked Example: S-Corporation Sale

An S corporation is legally sold for $10 million of stock consideration. Without a deemed-asset election, the shareholder generally compares proceeds with stock basis. With a Section 338(h)(10) election, the target is treated as selling assets. Receivables and inventory may create ordinary income, equipment can create Section 1245 recapture, and residual goodwill may produce capital gain.

The deemed gain passes through and increases shareholder stock basis before the deemed liquidation, preventing the same economic gain from being taxed twice. Even so, the mix of ordinary and capital character may leave the shareholder with materially more current tax than a straight stock sale.

The buyer values the election because the target receives stepped-up inside basis. A negotiation model should compare the present value of the buyer's future deductions with the seller's incremental federal and state tax, then reflect risk, timing, and transaction leverage.

Frequently Asked Questions

Is a 338(h)(10) election a stock sale or asset sale?

Legally it is a stock sale, but for federal income-tax purposes the target is generally treated as selling its assets and liquidating.

Can an individual buyer make a 338(h)(10) election?

A Section 338 election requires a corporate purchaser. Section 336(e) may be relevant in some qualifying transactions involving a noncorporate buyer.

Why would a seller agree?

The seller may receive a higher price, stronger deal certainty, or other negotiated value. The incremental ordinary income and state tax should be modeled first.

Section 338(h)(10) and Section 336(e) Elections: Stock Deal With Asset-Sale Tax Treatment