The once very popular 338 election has, since the trimming of the General Utilities doctrine in 1986, been toned down. However, it’s applicability still remains in select cases so it’s worth mentioning here as a strategy when it comes to selling a business.
In a section 338 deal, the buyer who purchases equal or greater than 80% of the seller’s stock within a 12-month window can elect to have the transaction treated as an asset purchase and not a stock purchase.
When the General Utilities doctrine was applicable before 1986, if there was no gain at the corporate level, electing for the 338 option would simply produce a basis step-up without added cost. Without the proper scenario a 338 election would generally create a recognized gain on the part of the buyer, thus creating an added cost for the acquisition.In today’s post-1986 world, triggering and immediate tax on potential future write-offs seems silly. Which is why the 338 only works in certain opportunities.
There are two general instances where exercising the 338 election makes sense in a transaction. Both are limited, but important to understand. When it works, it works and it’s best to be prepared even for the exceptions. First, if the seller has a large Net Operating Loss carry-forward (NOLs), the losses can be used to offset the taxable gains produced by using the 338 election. Using the NOLs and getting the basis step-up will help to mitigate the “tax hit.”
The second scenario involves C-corp subsidiaries. If the company to be acquired is a sub of another C corp, an election can be made under (h)(10) of section 338 wherein a single level tax is paid by the seller and there is a simple asset basis step-up for the buyer. This scenario is meant to mimic an asset sale followed by a liquidation. For in the situation of a subsidiary, the sub may have a taxable gain on its asset sale, the liquidation of the sub into the parent organization would not result in any taxes.