A corporate acquirer wants to acquire our stock but insists on making an Internal Revenue Code Section 338(h)(10) election. What financial and structural implications must we evaluate before agreeing to this election?

Question

Tyler Smith · Accepted Answer

A Section 338(h)(10) election is an agreement between a buyer and target shareholders to treat a qualified stock purchase as an asset purchase for federal income tax purposes. This gives the buyer the best of both worlds: they acquire your corporate stock, which simplifies the legal transfer of contracts, licenses, and operational permits, while getting a stepped-up tax basis in your company assets to accelerate future depreciation deductions.

For the seller, this election can be a financial disaster unless negotiated properly. In a pure stock sale, your proceeds are generally taxed at favorable long-term capital gains rates. Under a Section 338(h)(10) election, because the IRS views the transaction as a deemed asset sale followed by a liquidation, you become liable for corporate-level taxes, state franchise taxes, and ordinary income tax on depreciation recapture. The resulting tax drag can easily consume fifteen to twenty-five percent of your anticipated net cash proceeds.

You should never agree to a Section 338(h)(10) election in an LOI without a comprehensive tax gross-up provision. Require the buyer to pay an additional cash premium that makes you completely whole on an after-tax basis, ensuring you walk away with the exact dollar amount you would have kept in a straight stock sale.

Furthermore, the purchase agreement must mandate joint agreement on the Form 8883 asset allocation schedule before closing. If the buyer will not fund the tax differential and agree to fair asset allocations, reject the election and hold firm on a conventional stock transaction.