This article will explain Internal Revenue Code Section 338(g), which allows corporations, that buy a certain percentage of a target corporation’s stock and meet certain requirements, to make an election to treat the acquisition as an asset purchase instead of a stock purchase. In the right circumstances, a Section 338(g) election can be a very useful tool for tax purposes; however there are certain drawbacks, so you should consult an experienced tax attorney to determine whether the election would be a sound decision for your corporation.
Requirements for Section 338(g) Election
In general, in order to make an Section 338(g) election, the purchasing corporation must acquire through a “qualified stock purchase” 80% or more of the total voting power and 80% or more of the total value of the stock of the target corporation within a 12-month period. Preferred stocks are not counted for either purpose.
The election may only be made in taxable stock sales, and the purchaser must be a C corporation. Thus, individuals, partnerships and similar entities are not eligible to make the election. A corporation may purchase a foreign corporation and make the election; however, there are many complex international tax issues that may arise (such as the Subpart F rules).
Once the election is made, the target corporation is deemed as having sold all of its assets in a single transaction; it will be treated as a new corporation which purchased all of the assets of and is unrelated (for most purposes) to the old target corporation. The new (target) corporation also assumes any liabilities of the old target corporation.
Treatment of Basis of Stock & Assets
Normally, when a corporation purchases the net assets of a target company in a taxable stock sale, the purchaser will take a carryover basis in the acquired assets. However, by electing Section 338(g), purchasers will be allowed to take a stepped-up basis at the fair market value purchase price (as well as taking the stock at the FMV price), and the transaction will be deemed for the purposes of the section, as an asset sale. The election is made unilaterally by the purchasing corporation.
Main Advantages and Disadvantages of the Election
The primary advantage of a Section 338(g) election is that by treating the purchase as an asset sale, the purchaser is likely to be able to deduct depreciation and amortization expenses associated with the assets and intangibles; other tax credits may also apply.
The primary disadvantage, however, is that the deemed asset sale may trigger a taxable gain for the acquiring corporation. Conversely, the target corporation’s shareholders will be treated as having sold their shares, and thus will have a taxable gain or loss on the sale of their stock.
Thus, an acquiring corporation must consider whether making the election is worthwhile from a tax perspective. Generally, usable tax credits or Net Operating Losses of the target corporation will be necessary in order to consider making the election.
Contact Sherayzen Law Office for Tax Planning Help With Business Acquisitions
If you are planning to acquire another business and would like to explore the tax consequences of such purchase (or explore alternative structuring of such purchase), contact Sherayzen Law Office. Our tax firm has extensive knowledge of corporate tax law and we will use our reliable experience to help you achieve your acquisition goals in a tax-sensitive way.