The Internal Revenue Code allows buyers and sellers of shares of an S corporation to make a Section 338(h)(10) election to have a qualifying stock purchase treated as a deemed asset purchase for federal income tax purposes. A 338(h)(10) election is a joint election that requires an agreement between all of the selling shareholders and the prospective buyer. As a result of this election, a sale of shares for legal purposes will be treated as a sale of assets for tax purposes, resulting in different tax consequences for the buyer and seller that selling shareholders should understand.
It is important to note that a section 338(h)(10) election will adjust the tax base of the assets of Corporation S in the hands of the purchaser to fair market value. The buyer may receive additional tax benefits as a result, including depreciation and depreciation of the purchase price of the assets for federal income tax purposes, and resulting future tax deductions for the amount paid. over the tax life of the assets acquired.
What happens when you make an election under section 338(h)(10)?
For tax purposes, the selling company is considered to have sold all of its assets and is liquidated even though legally the selling company still exists.
Specifically, the following events are deemed to have occurred:
- The buyer creates a new company (new target).
- The new target buys the assets of the target company (old target).
- The old liquid target in the hands of the seller and final return.
- Generally, there is only one level of tax imposed which is on the deemed sale of assets.
- The sale of shares is ignored and the deemed liquidation is exempt from tax for selling shareholders.
Where a corporation purchases the shares of another (target) corporation and the purchaser corporation elects under section 338, the “new” target corporation which is then deemed to purchase all of the assets of the old target must use the same employer identification number as the old target used.
Tax Consequences of Election Under Section 338(h)(10)
The sale of stock is treated as a taxable sale of all of Target’s assets for US federal income tax purposes only. Not for information reporting, payroll taxes, sales and use tax, and other non-tax purposes.
For legal reasons, the transaction is a sale of shares. Therefore, the target’s liabilities are transferred, including any undisclosed or contingent liabilities. In contrast, in a direct asset purchase, the buyer is liable only for the liabilities expressly assumed or guaranteed by the assets acquired.
If the target is an S corporation, its S status continues until the close of the acquisition date, including deemed sale of assets and deemed liquidation, despite the general rule that S status terminates at the beginning of the day on which it acquires ineligible property. corporate shareholder.
The target S-Corporation therefore files a final S-Corporation return through the end of the acquisition date, which includes the deemed sale of assets.
The gain on the assets of Company S is passed through to the shareholders of Company S. The liquidation of target Company S is a Section 331 taxable liquidation, but the gain on the assets of the S Corporation is not taxed twice because the gain on the sale increases the shareholder base in their S Corporation shares. Typically, this is a level of tax imposed on the gains recognized by the former target on the deemed sale of assets.
How to make the section 338(h)(10) election
The joint election is required by the buyer and the seller(s), i.e. the buyer company and the common parent company of a consolidated seller group/seller affiliate or one or more shareholders of the company S.
The common parent of a consolidated group must provide a copy of the election statement to target no later than the target’s tax return due date. If Seller and Target are members of an Affiliate Group but do not file a Consolidated Statement, Seller and Target must include the Choice Statement on their respective filings. If the target is an S corporation, all shareholders of the target, including shareholders who do not sell target shares, must participate in the election.
Form 8023 must be filed by the acquiring company with the Internal Revenue Service Center, where it files its annual return. A copy of Form 8023 must be attached to the Old Target’s, New Target’s and Purchaser’s tax returns for the year that includes the acquisition date. Failure to do so will not invalidate the election. In addition, the old target and the new target must be attached Form 8883 to the income tax return showing the effects of the deemed transaction.
When to make the election under section 338(h)(10)
Elections must be made no later than the 15th day of the ninth month beginning after the month in which vesting takes place. An automatic 12-month extension may be available. Once made, the election is irrevocable.
When deciding on the right tax structure for buying a business, there are many decisions to be made that have many different implications. However, the decision comes down to whether the buyer wants to buy assets or buy shares and forfeit the graduated tax benefit. The choice of section 338(h)(10) gives the buyer the possibility of having it both ways while obtaining this advantage.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Mark Gallegos, CPA, MST, is a tax partner on Porte Brown’s accounting and advisory services team in the Elgin, Illinois office. He advises, speaks and writes on international taxation, mergers and acquisitions, credits and incentives.
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