Buyers can acquire a target corporation’s stock for legal purposes but its assets for tax purposes, resulting in a stepped-up basis in the target corporation assets, thanks to one of two Section 338 elections. While the theory may be straightforward, knowing how to use the election is not simple.
Investors electing for Section 338 must know how each election functions in a stock sale, and they must also know how to calculate aggregate deemed sale price, adjusted grossed-up basis, and aggregate deemed asset disposition price, explains enrolled agent Vicki L. Mulak. Mulak covers these topics in Eli Financial webinar, “Section 338 & 336 Elections Explained—With Practical Examples.”
Splitting Stock from Assets Offers Tax Benefits to Purchaser
The Section 338 election was enacted by Congress in 1982 as a way to allow taxpayers to treat certain qualified stock purchases as asset acquisitions for federal income tax purposes, reports Corporate Finance Institute.
There are two elections under Section 338: the “regular” 338(g) and an “irregular,” 338(h)(10), explains Thomson Reuters Practical Law. The 338(h)(10) treats a “a stock acquisition of the target corporation generally as an asset acquisition for US federal income tax purposes. A buyer may want to make this election if it would receive a stepped-up basis in the target corporation’s assets.”
Meanwhile, the standard 338(g) imposes two levels of taxes: one for shareholders on the sale of the target stock and the other on the deemed asset sale by the target corporation.
A stepped-up basis can be defined differently depending on which context it’s being used in, but generally is a federal tax benefit that allows a buyer to significantly raise the stated value of the seller’s assets and increase depreciation on the to-be-acquired assets in order to take a larger current tax deduction, notes The Balance.
3 Key Terms for Section 338 Elections
Here are other Section 338 provision keywords you should become familiar with, says Mulak:
- Aggregate deemed sale price (ADSP): This can be calculated in one of two ways, notes Forbes writer Tony Nitti. (1) In cases where the buyer does not purchase all of a company’s stock, you must “gross up” the amount paid to arrive at a 100 percent value. (2) Once the purchase price has been grossed up, increase the ADSP by the seller’s liabilities as of the acquisition date.
- Adjusted grossed-up basis: This is the sum of the buyer’s gross-up basis in the recently-purchased stock, the new target’s liabilities, and other relevant items, reports The Tax Advisor.
- Aggregate deemed asset disposition price: The amount for which the old target is deemed to have sold all of its assets in the deemed asset disposition; it’s allocated among the target’s assets in the same way that ADSP is used to determine the amount that each asset is deemed to have been sold, according to U.S. Code.
Section 336 Elections: Treat Qualified Stock as Assets Sales
One final election which is handy to know about is Section 336(e), which allows the buyer to receive a step-up on the basis of the target’s assets. It applies in cases where a Section 338(h)(10) isn’t available, such as the sale of a partnership.
To be eligible, according to Royse Law, the following is required:
- The disposition must consist of at least 80% of all classes of target stock.
- The disposition must be either a taxable sale or exchange of stock, a taxable distribution of stock, or certain distributions of target stock.
- The disposition cannot be between related parties.
- Neither the target nor the seller can be foreign.
“If a transaction qualifies and the Seller makes the Section 336(e) Election, the actual sale or disposition of the stock is disregarded and the transaction is deemed to be a sale by the Target of its assets to a new unrelated corporation,” attorneys Lynn E. Fowler and Cristin A. Burke from Kilpatrick Townsend wrote.
Sections 338 and 336 elections can be critical components of a business purchase, notes Mulak in her webinar, “Section 338 and 336 Elections Explains—With Practical Examples.” Nail the concepts now so that you can properly advise clients who come armed with questions.
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