Using the Section 338(h)(10) Election

There are many tax considerations when buying or selling a business, as taxes can impact the value of the transaction. Section 338(h)(10) elections are commonly used to reduce tax liability in business transactions, though they come with important advantages and considerations. Thus, it’s recommended to consult an experienced lawyer to help you make informed decisions based on the facts surrounding your transaction.

The business law attorneys at MPL have extensive knowledge of mergers and acquisitions and are ready to provide you with the needed support. Read on to learn more, and contact us with your inquiries.

What Is the Section 338(h)(10) Election?

As a federal tax election, section 338(h)(10) is a section of the Internal Revenue Code. Typically, in a stock transaction, the buyer buys stock that will have basis outside the corporation in the amount of the purchase price. 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. When acquiring stocks in a company, a section 388(h)(10) election allows the buyer to treat the stock purchase as an asset for tax purposes.

Stock purchases generally do not trigger tax liabilities, though they prevent the buyer from stepping up the tax basis of the seller’s assets, potentially resulting in higher future taxes. The advantage of a section 388(h)(10) election is that the buyer can step up the basis in the seller’s assets to fair market value at the time of the transaction, potentially leading to tax savings. However, doing so can trigger various tax liabilities.

Benefits of Using a Section 338(h)(10) Election

A section 338(h)(10) election allows the buyer to get a stepped-up basis in the business assets inside the corporation following the sale. In other words, the buyer gets to depreciate and amortize assets inside the corporation. This helps — especially in a leveraged transaction — to offset net income from debt service payments or capex that may otherwise not be deductible to the pass-through shareholders. The seller usually pays more in taxes with asset-sale treatment and may demand a true-up of the purchase price to offset the additional taxes.

Drawbacks of Using a Section 338(h)(10) Election

Treating the stock purchase as an asset can trigger certain tax liabilities, such as sales taxes, depreciation recapture, and other state and local taxes. When the target company has large assets with significant built-in gain, implementing the election can be expensive. Additionally, the election can potentially impact the buyer’s ability to use the seller’s net operating losses and other tax attributes to offset future taxable income. The election removes the target company as a separate legal entity.

Further, a section 338(h)(10) election is only available in some cases, as the transaction must meet certain conditions. The election can also complicate the acquisition and usually requires tax planning and analysis to ensure parties get the best value. Hiring an attorney is ideal since they can offer professional advice, obtain regulatory approvals, and negotiate complex contracts.

Section 338(h)(10) Election Planning Tip

A section 338(h)(10) election works best in stock transactions with considerable goodwill value. The seller will be taxed on the goodwill at the same rate as on the stock sale. In comparison, the buyer can amortize the goodwill over 15 years rather than have the value stuck on the outside basis of the stock.

This approach is a very useful tool in transactions involving government contractors or service firms. In these transactions, the buyer pays substantial money for access to contract arrangements or people, resulting in high goodwill values.

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MPL Law Firm has provided world-class legal solutions to businesses for decades. Our team has developed impressive expertise in relevant laws and industry best practices through years of practice, including mergers and acquisitions. We leverage our technical skills to implement strategies that suit our clients’ needs.

At MPL Law, we have three core values. First, we listen. Through collaborative engagements with our clients, we learn the unique needs of each situation and create paths to achieve the best possible results. Second, we’re honest. We provide practical legal solutions by thoroughly analyzing the matter and maintaining transparent communication. Third, we are forward-thinking. As the industry evolves, we learn the trends and best practices to help provide the needed support. Our goal is to provide innovative and efficient solutions to legal challenges.

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Learn More About Business Law

Considering how complicated a section 338(h)(10) election can be, it is best to consult an attorney before taking further steps.

The experienced business lawyers at MPL Law advise buyers and sellers of Main Street and middle market companies in private mergers and acquisitions. Our certified mergers and acquisitions advisors are recognized by the Alliance of Mergers and Acquisitions Advisors, an organization focused on the private middle market.

Want to learn more about business law or need professional support? Contact us now!