Section 338: How Stock Purchases Are Treated as Asset Acquisitions

Section 338 of the Internal Revenue Code offers a tax treatment option for stock purchases, allowing them to be treated as asset acquisitions. This can provide strategic benefits in mergers and acquisitions by enabling buyers to step up the basis of acquired assets, potentially leading to significant tax savings. Understanding this provision is essential for companies aiming to optimize their tax positions in such transactions.

Election Eligibility Criteria

To utilize Section 338, specific criteria must be met. The purchasing corporation must acquire at least 80% of the voting power and value of the target corporation’s stock within a 12-month period. This establishes the buyer’s control, a prerequisite for the election. The acquisition must qualify as a stock purchase under the Internal Revenue Code.

Both domestic and foreign corporations can make the election, though the tax implications may vary depending on jurisdiction. For example, a U.S. corporation acquiring a foreign target may encounter different tax consequences compared to a domestic acquisition. The election requires filing IRS Form 8023 by the 15th day of the ninth month following the acquisition date.

Approach to Deemed Asset Purchase Calculation

The Section 338 election treats a stock acquisition as an asset acquisition for tax purposes. This involves calculating the aggregate deemed sale price (ADSP), which represents the hypothetical sale price of the target’s assets. The ADSP includes the grossed-up basis of the target’s stock, liabilities, and other factors, forming the foundation for allocating the purchase price across asset classes.

The allocation follows an order mandated by the Internal Revenue Code, starting with cash and cash equivalents, followed by marketable securities, and then tangible and intangible assets. This ensures fair market value distribution, reflecting the economic value of each class. The residual method outlined in Section 1060 guides this allocation, influencing future depreciation and amortization deductions.

Allocation of Purchase Price to Assets

Allocating the purchase price to acquired assets requires precision, as it shapes tax implications and financial reporting. Assets are categorized into distinct classes, from cash to intangibles like goodwill and patents, with each category assigned a portion of the purchase price based on its fair market value.

Determining fair market value can be complex, particularly for intangible assets. Valuation specialists may be employed to ensure compliance with IRS guidelines. For example, intellectual property might be appraised using discounted cash flow analysis. This valuation aligns with IRS requirements and financial reporting standards like GAAP or IFRS.

The allocation has significant tax and financial reporting implications. Assigning more value to depreciable tangible assets can increase future tax deductions, while allocating more to non-depreciable assets like land or indefinite-lived intangibles may limit immediate tax benefits but enhance the balance sheet. Strategic allocation decisions require careful consideration of tax and financial reporting impacts and the company’s long-term goals.

Distinguishing 338(g) From 338(h)(10)

Section 338 includes two distinct elections: 338(g) and 338(h)(10), each with unique tax implications. The 338(g) election, often used in cross-border acquisitions or with foreign entities, is made by the purchasing corporation. The target is treated as if it sold its assets, potentially triggering immediate tax liabilities. This benefits buyers seeking to step up asset bases without altering the seller’s tax position.

In contrast, the 338(h)(10) election, typically used in domestic transactions involving S corporations or subsidiaries of consolidated groups, requires agreement from both buyer and seller. It treats the transaction as if the target sold its assets and liquidated. The seller recognizes gains at the shareholder level, often qualifying for capital gains treatment and avoiding double taxation. This election works best when both parties align on a favorable tax outcome.

Adjustments to Tax Attributes

A Section 338 election significantly alters the target corporation’s tax attributes. The target is treated as having sold all its assets in a taxable transaction, triggering recognition of gain or loss at the corporate level. This resets the basis of the target’s assets to their fair market value, enabling the buyer to benefit from enhanced depreciation and amortization deductions. However, pre-existing tax attributes like net operating losses (NOLs) or tax credits are eliminated.

For sellers, tax consequences depend on the election type. In a 338(h)(10) election, the seller recognizes gain or loss as if the target sold assets, potentially offsetting gains with NOLs or other attributes. In a 338(g) election, these tax consequences are borne by the target corporation. Buyers must carefully evaluate these adjustments, as eliminating tax attributes could offset the benefits of a stepped-up basis.

The timing of these adjustments is crucial, as they take effect on the acquisition date. This timing impacts financial reporting, as adjustments must be reflected in purchase accounting under GAAP or IFRS. Deferred tax liabilities may arise from the stepped-up basis if the fair market value exceeds the tax basis of the assets, requiring careful reporting on the buyer’s balance sheet.

Key Filing Steps

Executing a Section 338 election requires strict adherence to IRS filing procedures. The election is documented on IRS Form 8023, which must be filed by the 15th day of the ninth month following the acquisition date. Missing this deadline forfeits the election opportunity, with significant tax implications for the buyer.

Form 8023 must be accurate, detailing the acquisition date, identities of the buyer and seller, and a description of the target corporation. It must also specify whether the election is under 338(g) or 338(h)(10). Supporting documentation, such as purchase agreements and valuation reports, may be required to substantiate the election and calculations.

After filing, the buyer must ensure the election is reflected in the target’s tax filings, including reporting the deemed sale of assets on the target’s final tax return. For 338(h)(10) elections, the seller must also report the transaction on their tax return, recognizing any gain or loss. Coordination between buyer and seller is essential to meet reporting obligations and avoid disputes or penalties. Consulting tax advisors can help streamline the process and ensure compliance with IRS requirements.