338 Election: Stock Sale

The once very popular 338 election has, since the trimming of the General Utilities doctrine in 1986, been toned down. However, its applicability still remains in select cases so it is 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 an immediate tax on potential future write-offs seems counterproductive.

Which is why the 338 only works in certain opportunities.

Scenarios Where a 338 Election Makes Sense

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 is 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 subsidiary of another C-corp, an election can be made under section 338(h)(10) wherein a single level of 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. In the situation of a subsidiary, the sub may have a taxable gain on its asset sale, but the liquidation of the sub into the parent organization would not result in any additional taxes.

Asset Purchase vs. Stock Purchase: Why It Matters

To understand why the 338 election has value in specific contexts, it helps to understand the fundamental difference between an asset purchase and a stock purchase from the buyer's perspective. In a straight stock purchase, the buyer acquires the entity as-is — including all of its historical tax liabilities, pending litigation, and existing tax basis in its assets. There is no step-up: if the seller paid $1 million for equipment now worth $5 million, the buyer inherits the original $1 million basis and cannot depreciate the full current value.

In an asset purchase, by contrast, the buyer pays fair market value for each asset and receives a stepped-up basis in those assets, which translates into larger future depreciation and amortization deductions — a meaningful economic benefit. The 338 election allows the buyer to achieve this asset-purchase tax treatment while legally completing a stock purchase, which may be preferred for non-tax reasons (such as preserving the target's contracts, licenses, or permits). For companies exploring how deal structure affects their position, understanding the disadvantages of a stock deal is an important starting point.

When the 338 Election Is Not Worth It

In most circumstances outside of the two scenarios described above, a 338 election is not advisable because it accelerates taxable income at the corporate level without a corresponding benefit that offsets that cost. Absent large NOLs or the (h)(10) subsidiary scenario, the buyer effectively pays twice — once for the acquisition and once in taxes — making the economics unattractive compared to simply structuring the deal as an outright asset purchase.

Transaction counsel and tax advisors should model out the after-tax proceeds under each structure before any election is made. This analysis is particularly important in transactions involving multiple entity types, where an election in one entity can have cascading effects across the structure. Proper preparation — including organizing financial and tax documentation in a virtual data room — helps ensure both sides have the information needed to model these tradeoffs accurately.

Practical Considerations for Deal Teams

The 338 election must be made jointly by buyer and seller (in the case of a standard 338) or by the selling consolidated group (in the case of a 338(h)(10)). The election is filed using IRS Form 8023 and must be submitted by the 15th day of the ninth month after the acquisition month. Missing this deadline forfeits the election entirely, so the deal timeline must account for it explicitly.

Buyers who pursue the 338 route should also confirm that the target entity is eligible. S-corporations, for instance, cannot be the subject of a standard 338 election, though a 338(h)(10) election can apply to S-corp targets when certain conditions are met. Given this complexity, the 338 election is a specialized tool best deployed with experienced M&A tax counsel. Teams working through sell-side preparation should raise the question of 338 eligibility early in deal structuring, not after terms are already negotiated.

Frequently Asked Questions

What is the difference between a 338 election and a 338(h)(10) election?

A standard 338 election can be made by any qualifying buyer (one that acquires at least 80% of the target's stock in a 12-month period), but it results in two levels of tax — one at the corporate level and one at the shareholder level — making it economically unattractive in most cases. The 338(h)(10) election applies specifically to the acquisition of a subsidiary from a consolidated corporate group or an S-corporation, and it results in only a single level of tax, making it far more commonly used in practice.

Can a 338 election be made without the seller's agreement?

In the case of a standard 338 election, the buyer alone makes the election — seller consent is not technically required. However, a 338(h)(10) election requires a joint election between buyer and selling consolidated group, so seller cooperation is essential. In practice, since the 338(h)(10) election often requires the seller to pay more in taxes than a straight stock sale would, the economic impact on the seller must be negotiated and often offset through a price adjustment.

How does a large NOL carry-forward affect the 338 analysis?

When a target company has substantial Net Operating Losses, those losses can offset the taxable gain triggered by the 338 election, effectively neutralizing the immediate tax cost that otherwise makes the election unattractive. In those cases, the buyer gets the step-up in basis — and the enhanced future depreciation — at little or no incremental tax cost. NOL carry-forwards are therefore a key diligence item in any potential 338 scenario and should be verified and quantified early in the process.