Selling a Business

338(h)(10) and Treating a Stock Sale as an Asset Sale

Understand the election that lets a legal stock sale be taxed as an asset sale — who can make it, what it does to the seller's tax character, how the gross-up is calculated, and the S corporation validity risk that can turn it into a disaster.

  • Expert
  • 9 min total
  • 12 chapters

What decision this helps you make: Whether to agree to a §338(h)(10) election, what to charge for it, and whether a different structure would achieve the same result more safely.

What this topic is

An election under IRC §338(h)(10) that, when made jointly by a corporate purchaser and the seller, treats a qualifying purchase of target stock as a deemed sale of the target's assets followed by a deemed liquidation. The buyer receives a stepped-up basis in the assets; the seller is taxed as if it had sold assets, which changes the character of a portion of the gain. This lesson also covers the related §336(e) election, which extends similar treatment where the purchaser is not a corporation.

Why it matters

The buyer wants amortisable basis; the seller wants capital gain. The election gives the buyer what it wants at the seller's expense, and the entire negotiation is about how much the buyer pays to compensate. Sellers who agree to it without computing the incremental tax give away real money. Sellers who agree to it with a defective S election can convert a single level of tax into two.

Who should learn it

Owners of S corporations and corporate subsidiaries considering a sale, and advisers modelling structure alternatives.

What you will understand

  • The eligibility requirements for a qualified stock purchase and who must consent
  • How the deemed asset sale changes the character of the seller's gain, and how to compute the incremental cost
  • How the buyer's benefit is valued and how a gross-up is negotiated
  • The S election validity risk, and when an F reorganisation is the safer route

Prerequisites

Common misconception

"The election is a tax formality that only affects the buyer." It changes the seller's tax bill, sometimes substantially, by converting part of what would have been long-term capital gain into ordinary income through depreciation recapture and by exposing the seller to state taxes in every jurisdiction where the target had assets or activity. It can also trigger a corporate-level tax where the S election turns out to have been defective, or where built-in gains exposure exists.