The information presented is only of a general nature, intended simply as background material, is current only as of the latest revision date, October 15, 2007, omits many details and special rules and cannot be regarded as legal or tax advice.

In a taxable sale of stock, the selling Target shareholders recognize gain or loss.

Acquiring, the purchaser, recognizes gain (or loss) on any appreciated (depreciated) property, other than its own stock, used to acquire the Target stock and obtains a fair market value basis for that stock.

Importantly, there is no change to the basis of the Target assets or to the other tax attributes of Target (although utilization of certain carryovers, e.g., net operating loss carryovers, may be limited).

Section 338 Elections

Acquiring, a corporate purchaser, can elect under section 338 to treat the purchase of the Target stock as a purchase of Target's assets if, in general, at least 80% of Target's stock is acquired by purchase during a 12-month period.

The purchase price for the assets reflects the price paid for the stock (adjusted where less than 100% of the stock is acquired) and the liabilities of Target. The allocation of that price among the categories of acquired assets is based upon their relative fair market values.

Target is treated as having sold all its assets, subject to all its liabilities, at the close of the acquisition date and then to have purchased those assets as a new corporation as of the beginning of the next day.

The tax imposed on the deemed sale of Target assets under section 338 is borne by Acquiring, the buyer.

Various consistency rules apply to prevent, for example, increasing the basis of and paying tax on the unrealized appreciation of only selected T assets.

After the repeal of General Utilities, a section 338 election rarely makes sense as the election generally results in recognized gain at least equal to the increase in the basis of Target's assets. The tax on the gain is payable immediately while the benefit from the increased basis is realized over time.

Section 338(h)(10) Election

If Target is a member of a consolidated return group before the stock purchase then the parties can elect under section 338 and section 338(h)(10) to treat Target again as selling all its assets to itself, but prior to Target leaving the selling consolidated return group.

If a section 338(h)(10) election is made, the tax cost of increasing the basis of Target's assets is borne by the selling consolidated return group.

However, selling groups will agree to enter into the section 338(h)(10) election because they then recognize no gain on the sale of the Target stock. In many cases, therefore, the tax cost of the transaction to the selling group will not increase substantially by virtue of the section 338(h)(10) election. If that tax cost does increase, it can often be in the buyer's interest to compensate the selling group for making the section 338(h)(10) election. Under regulations adopted in January of 1994, a section 338(h)(10) election can be made with regard to an otherwise qualifying acquisition of stock of an S corporation, but all shareholders of the S corporation must join in the election.

© 2005