The buyer insists on treating our stock purchase as an asset purchase using a Section 338(h)(10) election for tax depreciation, which will trigger ordinary income taxes for us. How do we negotiate the tax gross-up to ensure we walk away with the exact same net proceeds?

Question

Tyler Smith · Accepted Answer

In a standard stock sale, the seller pays long-term capital gains tax on the total gain. But corporate buyers frequently demand a joint Section 338(h)(10) election. This election treats a stock purchase as a deemed asset sale for tax purposes, giving the buyer a stepped-up depreciation basis on all tangible and intangible assets while shielding them from historical non-tax liabilities.

For you as the seller, this election can be catastrophic. It converts capital gain into ordinary income on depreciated machinery, software, and inventory recapture under Section 1245, while potentially exposing you to state-level corporate taxes. If the buyer wants this step-up, they must fully fund the difference.

Negotiate the tax gross-up using these rules:
- Require a binding covenant in the Letter of Intent stating that if a Section 338(h)(10) election is requested, the buyer must pay a full cash tax gross-up. The gross-up must yield the exact net after-tax cash proceeds you would have realized under a conventional stock sale without the election.
- Mandate a dynamic gross-up calculation. The gross-up must cover not only the base tax differential, but also the additional tax triggered by receiving the gross-up payment itself (a tax on a tax).
- Specify that the final asset allocation under Section 1060 must be mutually agreed upon prior to close, setting clear limits on how much value can be pushed into recapture categories.

Do not give away an asset step-up worth millions in tax deductions to the buyer unless every dollar of your additional tax bill is paid at close.