As the Partner in Charge of the Tax Practice at Sobel & Co., one of my responsibilities is to work with our professionals to make sure that our clients have access to the best tax strategies.
As such, we have had the opportunity to help clients who are purchasing a corporation to make the right choices. Usually there are really only two ways to buy a business: purchase the assets or purchase the stock. Although I will briefly discuss some of the challenges with these two options, there is one way to get the best of both worlds, and that is to acquire the stock for legal purposes and at the same time acquire the assets for tax purposes. This transaction is actually possible when the purchaser takes advantage of the 338 (h) (10) election.
Buyers do not usually want to purchase stock because stock is neither depreciable nor amortizable because of its indefinite useful life. So when stock is purchased, there is no tax benefit until the shares are sold. Buyers seeking more immediate tax benefits avoid stock purchases.
Unlike a stock purchase, when a buyer acquires the selling company’s assets, he can allocate the purchase price among the acquired hard assets- and any amount that was paid in excess of the value of the hard assets is then allocated to intangible assets, such as good will. The result is that the buyer can begin depreciating or amortizing the entire purchase price. It is the immediate tax benefit that results from purchasing assets in what is known as a ‘stepped up basis’ that makes this the preferred choice for most people who are interested in buying an existing corporation.
What’s the benefit of the 338 election?
It seems pretty clear that purchasing assets is the better alternative from a strategic tax perspective but under specific circumstances, this may not be possible. For example, there may be nontax restrictions. This could occur if the corporation that is to be purchased has existing contracts that cannot be easily transferred to the new owners. Therefore, legalities do not permit the purchase of assets. Instead, the buyer is forced to purchase stock only – which is less desirable because of the buyer cannot take advantage of any tax benefits but must wait until sometime in the future when he is prepared to sell the corporation.
This is when 338 (h)(10) election becomes an excellent solution.
When the stock of one corporation is being purchased by another corporation, the buyer and seller can agree together to a 338 election. The only caution is that there are limits on the types of corporate buyers and sellers who are eligible for using the 338 election. So keep these parameters in mind when considering a purchase:
- The buyer must be a C or S corporation – partnerships and individuals are not considered corporations.
- The seller must be a corporation that meets one of these three descriptions:
- It is a subsidiary in a consolidated group with 80% of its stock owned by others in the group
- It is a subsidiary in a group with 80% of the stock owned by others in the group and it is eligible to file a consolidated return but opts not to do so
- It is an S corporation
These are the criteria that are at the foundation of a 338 election. Once the qualified purchasing corporation and the selling corporation agree to the election, there are two steps they need to take:
- The corporation that is being sold behaves as if it has sold all its assets in a taxable transaction, resulting in its liquidation. This is the stepped up basis that allows for the tax benefits to take place for the purchasing corporation;
- To fulfill its part in the election, the purchasing corporation is required to participate in a taxable transaction, acquiring at least 80% of the stock of the company that is to be liquidated (and now become nonexistent). It is important to note that this qualified stock purchase can be accomplished over a 12 month period.
So, in the 338 election scenario, what transpires is this: Simply put, a stock acquisition is treated as an asset acquisition.
The purchasing corporation acquires the selling corporation’s stock for legal purposes (by executing a qualified stock purchase – QSP), thus protecting the non-transferable assets. But at the same time, the buyers acquire the sellers’ assets for tax purposes, giving them the stepped up basis in assets that enables the amortization or depreciation that leads to immediate tax benefits for the purchasing corporation.
This election is simple in its definition but can become complicated in its execution. If you believe that a 338 (h)(10)election could provide potential tax benefits for your company if you are considering the purchase of another company, please contact your financial advisor or feel free to reach out for me, Ken Bagner, at [email protected] or call me at 973-994-9494. I will be happy to walk you through the implications for your situation.
Citations. Because of the technical aspect of the 338(h)(10) election and the specifics that are part of the resolution, some of the details shared in this blog were researched for accuracy at www.forbes.com;www. uspracticallaw.com; Practicing Law Institute “Tax Strategies for Corporate Acquisitions…” authored by Mark J. Silverman, Steptoe & Johnson LLP.