Using the Section 338(h)(10) Election
Most people have heard of “Section 338(h)(10),” but not as many know when and how to use it. Normally, in a stock transaction, the buyer buys stock that will have basis outside the corporation in the amount of the purchase price for the stock. The amount paid for the stock cannot be depreciated or amortized to offset future taxes. The assets inside the corporation carry-over the basis without any change. A Section 338(h)(10) election can be used in a stock sale involving S-corporations to give the transaction asset sale treatment. This means the buyer gets a stepped-up basis in the business assets inside the corporation following the sale. This is significant because the buyer gets to depreciate and amortize assets inside the corporation which helps the buyer, especially in a leveraged transaction, offset net income from debt service payments or capex that may not be deductible to the pass-through shareholders. The seller usually pays more in taxes with asset-sale treatment so many times a seller demands a true-up of the purchase price to offset the additional taxes.
Planning Tip: A Section 338(h)(10) election works best in stock transactions with considerable goodwill value because the seller will be taxed on the goodwill at the same rate it is taxed on the sale of stock. The buyer on the other hand can amortize the goodwill over 15 years rather than have the goodwill value “stuck” in the outside basis of the stock. We have found this to be a very useful tool in transactions involving government contractors or services firms where the buyer is paying substantial money for access to contract arrangements or people resulting in high goodwill values for the transaction.
Andrew J. Miller, JD, CM&AA® advises buyers and seller of main street and middle market companies in private mergers and acquisitions. He is recognized as a Certified Mergers & Acquisitions Advisor® by the Alliance of Mergers & Acquisitions Advisors, an organization focused on the private middle market. He can be reached at (717) 845-1524, or email@example.com.