The corporate buyer wants to structure our transaction as a Section 338(h)(10) election to treat the stock sale as an asset sale for tax purposes. Since this triggers massive ordinary income depreciation recapture, how do we structure a tax gross-up?

Question

Tyler Smith · Accepted Answer

A Section 338(h)(10) election is highly advantageous for buyers because it allows them to step up the tax basis of your assets and write them off over time. However, this structure shifts a heavy tax burden to you. Instead of paying capital gains on a stock sale, you will be hit with ordinary income tax rates on depreciation recapture and goodwill allocation. You should never agree to a Section 338(h)(10) election without a mandatory tax gross-up provision. This clause requires the buyer to increase the total purchase price of the business to fully compensate you for the incremental tax liability. To execute this, require both your CPA and the buyer's tax counsel to run parallel tax simulations comparing a straight stock sale to the proposed asset sale. The buyer must pay the exact difference in cash at closing, ensuring that your net, after-tax proceeds are identical to what you would have received in a stock transaction. If the buyer resists, remind them that the tax benefits they gain from the asset step-up have a quantifiable net present value. They are buying tax deductions, and they must pay for that value rather than stealing it from your net proceeds.