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Stock Purchases Treated as Asset Acquisitions

In the past, we’ve covered complex business transactions.  We learned how they may obtain optimal tax treatment by utilizing particular sections of the tax code. We’ve discussed the numerous variations of tax-deferred reorganizations under Section 368, for instance, as well as the tax-deferred exchange of property under Section 1031. Both of these sections can generate huge benefits for businesses and individuals; reorganizations can defer substantial gain from the sale of corporate stock and assets, and exchanges can defer recognition of capital gain taxes from the sale of real estate. Section 338 is yet another tool which, when used properly, can help taxpayers achieve more favorable tax treatment by having stock purchases treated as asset acquisitions 

Why Have Stock Purchases Treated As Asset Acquisitions

Section 338 allows corporations to have their stock purchases treated as asset acquisitions for federal income tax purposes.  That happens when they acquire both stock and assets from specific types of corporate entities. Treating stock as assets can generate substantial tax benefits for corporations.  That’s particularly true when Subsection 338(h)(10) is used to avoid double taxation (of both the stock and assets). In this post, we will introduce some of the key principles of Section 338.  We’ll then briefly cover the distinguishing features of S Corporations. We will then go over the basic mechanics of Section 338 and give a sense of how these transactions are structured.  

Basic Section 338 Principles 

Section 338 enables the stock in a stock and asset acquisition to obtain the same treatment as an asset for tax purposes. There are two types of 338 transactions.  The first is a regular 338(g) transactions.  The other includes 338(h)(10) transactions. In a regular 338(g) transaction, there is double taxation.  That is, the shareholders tax is on the sale of their stock.  Then the target corporation tax is on the sale of its assets. Regular 338(g) transactions are less common than 338(h)(10) transactions.  That’s because of the double taxation involved with the former.  

Section 338(h)(10) transactions can confer substantial benefits to the parties involved because only the asset portion of the transaction is subject to tax.  

Defining S Corporations 

Section 338 may only be used when the target corporation is either an S corporation, a member of a consolidated group, or a non-consolidated selling affiliate. An S corporation is a corporation which has no more than 100 shareholders.  It has the same pass-through tax treatment as a partnership or other pass-through entity. S corporations file a specific form – Form 1120S – when they complete their tax return.  This form reports the net gain or loss which has flowed through to the individual shareholders. Corporations must make a special election to receive status as an S corporation. That’s done so that they can reap the advantages of pass-through treatment.  

Let me repeat an important point.   One of these three types of entities must be the target corporation in order to use Section 338 in the transaction.

General Mechanics of Section 338(h)(10) 

To conduct a Section 338(h)(10) transaction, both parties to the deal must provide their express consent that Section 338 will apply. The election is a joint decision. It cannot be unilateral; otherwise the transaction won’t qualify under 338. Once an agreement is made, the stock sale of the target corporation is ignored for tax purposes.  The asset portion of the transaction will be taxed as it normally would as an asset acquisition. The target corporation will therefore only be subject to tax on the sale of its assets.  Nonetheless, both the stock and the assets will both receive treatment as asset acquisitions for tax purposes. This means that both the stock and assets will receive the “stepped up basis” treatment when sold to the acquiring corporation. The acquiring corporation can therefore take advantage of increased depreciation deductions.  It can also maximize its access to capital.  

Variations

While the benefits of these more common 338(h)(10) can be plentiful under the right circumstances, there are situations in which this variation may not be desirable. For instance, if the basis of the target corporation’s assets is lower than the basis of its own stock, then the target corporation may be disadvantaged due to the fact that additional taxation may be incurred as a result of this discrepancy. However, depending on the specific facts, the acquiring corporation may decide to simply compensate the target corporation for the additional taxation in order to complete the deal.

Other factors may also come into play to influence whether either a regular 338(g) or 338(h)(10) transaction is the best strategy.  Accordingly, anyone considering a 338 transaction really should consult with a qualified professional.  Do this BEFORE making a decision on which variation to pursue. In the future, we will come back and look at one or more specific examples of Section 338 transactions.  We’ll then get a clearer sense of how to structure these deals so that stock purchases can receive treatment as asset acquisitions.

Benefits Of Stock Purchases Treated as Asset Acquisitions

The principles and mechanics of Section 338 are no less complicated than those underlying many other tax code sections. Given their complexity, a great deal of work is necessary to structure these transactions and ensure that all applicable rules are followed. This work is not without its potential rewards, however: in many cases, a Section 338 transaction can help corporations avoid considerable amounts of tax on the sale of stock.

Contact a Qualified New York City Tax Attorney Today!

The professionals at Mackay, Caswell & Callahan, P.C. devote considerable time and energy to mastering rules and regulations.  These include transactions such as qualified stock purchases under Section 338.  You don’t have to shoulder this burden alone. If you’re contemplating Section 338 to treat stock purchases as asset acquisitions, contact a top NYC tax attorney today. We’ll promptly review your situation.