What is a Section 338 election, and what is its primary purpose for a C Corporation acquisition?

A Section 338 election, specifically a Section 338(h)(10) election for a target S corporation or a Section 338(g) election for a target C corporation, allows a stock acquisition to be treated as an asset acquisition for tax purposes. Its primary purpose is to step up the basis of the target corporation's assets to their fair market value (FMV) on the acquisition date, enabling the buyer to claim higher depreciation and amortization deductions post-acquisition. This election is generally made by the acquiring corporation, or jointly with the selling shareholders in the case of an (h)(10) election, as outlined in Treas. Reg. § 1.338-1.

Who is eligible to make a Section 338 election, and what are the fundamental requirements?

A Section 338 election can generally be made by a purchasing corporation that acquires at least 80% of the total voting power and 80% of the total value of the stock of another corporation (the target) within a 12-month acquisition period. This is known as a 'qualified stock purchase' (QSP) under IRC Section 338(d)(3). The purchasing corporation must be a C corporation, and the target can be either a C corporation or an S corporation. The election is irrevocable once made.

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

A Section 338(g) election is made unilaterally by the purchasing C corporation for a target C corporation, resulting in a deemed asset sale by the target and a deemed liquidation for tax purposes, creating a 'double tax' event (corporate-level gain and shareholder-level gain on liquidation). A Section 338(h)(10) election, available for target S corporations or consolidated C corporation subsidiaries, is made jointly by the buyer and seller(s). It treats the target as selling its assets and then liquidating, but the gain is generally recognized only at the shareholder level (for S corps) or within the consolidated group (for C corp subsidiaries), avoiding the double tax of a 338(g) election.

How is a Section 338 election actually made, and what forms are required?

A Section 338 election is made by filing Form 8023, 'Elections Under Section 338 for Corporations Making Qualified Stock Purchases.' This form must be filed by the 15th day of the 9th month beginning after the month in which the acquisition date occurs. For a Section 338(h)(10) election, both the purchasing corporation and the selling shareholders (or the common parent of the selling consolidated group) must sign Form 8023. Failure to timely file or properly complete the form can invalidate the election.

What are the tax consequences to the 'old target' corporation and its shareholders under a Section 338(g) election?

Under a Section 338(g) election, the 'old target' corporation is deemed to sell all of its assets to a 'new target' corporation at their fair market value on the acquisition date. This deemed sale triggers corporate-level gain or loss recognition. Subsequently, the old target is deemed to liquidate, distributing the proceeds to its shareholders, which triggers a second level of tax at the shareholder level on the difference between the liquidation proceeds and their stock basis. This 'double taxation' is a significant drawback of the 338(g) election.

What are the tax consequences to the 'old target' corporation and its shareholders under a Section 338(h)(10) election?

For a Section 338(h)(10) election, the 'old target' corporation is deemed to sell all of its assets to the 'new target' corporation at FMV, and then is deemed to liquidate. However, for a target S corporation, the gain or loss from the deemed asset sale flows through to the selling shareholders, increasing or decreasing their stock basis, and then the deemed liquidation is generally tax-free. For a target C corporation that is a subsidiary in a consolidated group, the gain or loss is recognized by the selling consolidated group, and the deemed liquidation is tax-free within the group, effectively avoiding a separate shareholder-level tax.

What is the 'aggregate deemed sale price' (ADSP) and 'adjusted grossed-up basis' (AGUB) in a Section 338 election, and why are they important?

ADSP is the amount for which the old target is deemed to have sold its assets, used to determine the old target's gain or loss on the deemed asset sale. AGUB is the new target's deemed cost basis in the acquired assets, used to allocate basis among the new target's assets. Both are calculated using complex formulas involving the buyer's purchase price, liabilities assumed, and acquisition costs, as detailed in Treas. Reg. § 1.338-4 and § 1.338-5. They are critical for determining the tax consequences of the election for both buyer and seller.

How is the stepped-up basis allocated among the target's assets after a Section 338 election?

The AGUB is allocated among the target's assets using the residual method, as prescribed by IRC Section 1060 and Treas. Reg. § 1.338-6. Assets are classified into seven classes (Class I through Class VII), and the AGUB is allocated sequentially, first to cash and cash equivalents, then to actively traded personal property, then to accounts receivable, inventory, and so on, with any residual amount allocated to goodwill and going concern value (Class VII). This allocation determines the depreciation and amortization schedule for the new target.

What are the key advantages for the buyer in making a Section 338 election?

The primary advantage for the buyer is the step-up in the basis of the target's assets to their fair market value. This allows the new target to claim higher depreciation and amortization deductions on these assets in future periods, reducing its taxable income and cash tax outlays. Additionally, it can eliminate certain tax attributes of the old target, such as net operating loss (NOL) carryforwards, which might otherwise be subject to limitations under Section 382.

What are the key disadvantages or risks for the buyer in making a Section 338 election?

For a 338(g) election, the main disadvantage is the double taxation triggered, which often makes it economically unattractive unless the target has significant NOLs to offset the deemed asset sale gain. For both 338(g) and 338(h)(10), the administrative burden and complexity of the election, including asset appraisals and detailed basis allocations, can be substantial. There's also the risk of IRS scrutiny regarding asset valuations and the allocation of basis, particularly to goodwill.

What are the key advantages and disadvantages for the seller in agreeing to a Section 338(h)(10) election?

For the seller, the primary advantage of an (h)(10) election is avoiding the double taxation inherent in a 338(g) election or a stock sale followed by a liquidation. For S corp shareholders, it often results in capital gains treatment for the deemed asset sale, which can be beneficial. However, the deemed asset sale might generate more gain than a simple stock sale if the target's asset basis is lower than the shareholders' stock basis. Sellers also bear the administrative burden of calculating and reporting the deemed asset sale.

Can a Section 338 election be made for a foreign target corporation?

Yes, a Section 338 election can be made for a foreign target corporation, subject to specific rules and considerations under IRC Section 338(h)(6) and Treas. Reg. § 1.338-9. The deemed sale of assets by a foreign target can have significant U.S. tax implications, including Subpart F income, GILTI, or E&P adjustments for U.S. shareholders. The interaction with foreign tax credits and treaties must be carefully analyzed, as the deemed sale may not be recognized in the foreign jurisdiction.

What are common mistakes made when attempting a Section 338 election?

Common mistakes include failing to meet the 'qualified stock purchase' requirements, missing the filing deadline for Form 8023, incorrect calculation of ADSP or AGUB, improper allocation of basis among assets (especially to goodwill), and inadequate documentation to support asset valuations. For (h)(10) elections, failing to obtain proper consent from all necessary selling shareholders or the consolidated group parent can invalidate the election. These errors can lead to disallowance of the step-up and potential penalties.

What is the impact of a Section 338 election on net operating loss (NOL) carryforwards of the target corporation?

A Section 338 election generally eliminates the target corporation's pre-acquisition net operating loss (NOL) carryforwards and other tax attributes. The 'old target' is deemed to liquidate, and its tax attributes do not carry over to the 'new target.' This can be a significant consideration, as any existing NOLs cannot be used to offset future income of the new target, although they might be used to offset gain from the deemed asset sale in a 338(g) election.

How does Section 338 interact with Section 1060 regarding asset acquisitions?

IRC Section 1060 generally applies to asset acquisitions where the buyer's basis is determined by the cost of the assets. The residual method of allocating purchase price to assets, as prescribed by Section 1060, is explicitly adopted and applied to Section 338 elections through Treas. Reg. § 1.338-6. Both sections mandate the use of Form 8594, 'Asset Acquisition Statement Under Section 1060,' for reporting the allocation of purchase price, ensuring consistency between buyer and seller.

What are the IRS audit risks associated with a Section 338 election?

IRS audit risks primarily revolve around the valuation of assets and the allocation of the AGUB, particularly the amount allocated to goodwill and other intangibles. The IRS scrutinizes whether the valuations are supported by independent appraisals and whether the allocation method adheres strictly to the residual method rules. Discrepancies between buyer and seller reporting on Form 8594 can also trigger an audit. The IRS may challenge the fair market value assigned to depreciable or amortizable assets to reduce future deductions.

Are there any recent legislative changes or proposed regulations impacting Section 338 elections?

While there haven't been recent significant legislative changes directly to Section 338 itself, broader tax law changes, such as those impacting corporate tax rates (e.g., TCJA 2017) or depreciation rules (e.g., bonus depreciation), indirectly affect the economic attractiveness of a Section 338 election. For instance, lower corporate tax rates reduce the value of depreciation deductions, potentially making the step-up less valuable. Practitioners must monitor proposed regulations and IRS guidance for any indirect impacts.

Can a Section 338 election be revoked once made?

No, a Section 338 election is generally irrevocable once made. Treas. Reg. § 1.338-1(b)(2) explicitly states that an election under Section 338 is irrevocable. This underscores the importance of careful planning and due diligence before making the election, as the tax consequences are permanent. Limited exceptions for revocation may exist in extraordinary circumstances, such as a material mistake of fact, but these are rare and require IRS consent.

What is the impact of a Section 338 election on state income taxes?

The state income tax treatment of a Section 338 election varies significantly by jurisdiction. Most states generally conform to the federal treatment, recognizing the deemed asset sale and step-up in basis. However, some states may not conform, or may have their own specific rules for calculating state-level gain or loss, or for allocating the stepped-up basis. It is crucial to analyze the tax laws of each state where the target corporation operates to understand the full state tax implications.

When would a buyer typically prefer a Section 338(h)(10) election over a direct asset purchase?

A buyer typically prefers a Section 338(h)(10) election over a direct asset purchase when the seller insists on selling stock for non-tax reasons (e.g., avoiding assignment clauses in contracts, preserving licenses) but the buyer desires the tax benefits of an asset purchase (i.e., basis step-up). The (h)(10) election provides the best of both worlds: a stock acquisition for legal/contractual purposes and an asset acquisition for tax purposes, often with a single level of tax for the seller.

C-Corp Section 338(h)(10) Election — 2026 Guide

Overview: C-Corp Section 338(h)(10) Election for 2026

The Section 338(h)(10) election is a powerful tax strategy employed in mergers and acquisitions (M&A) involving C-corporations. It allows a stock purchase to be treated as an asset purchase for tax purposes, offering significant benefits, particularly to the buyer, by providing a stepped-up basis in the acquired assets. This guide will delve into the intricacies of this election, outlining its definition, eligibility criteria, claiming process, relevant 2026 tax considerations, common pitfalls, and the pertinent IRS code section.

What is the C-Corp Section 338(h)(10) Election?

In a typical stock acquisition, the buyer acquires the target company\'s stock, inheriting its historical tax basis and liabilities. Conversely, in an asset acquisition, the buyer purchases the individual assets of the target, receiving a new tax basis (often stepped up to fair market value) and generally avoiding the target\'s historical liabilities. The Section 338(h)(10) election offers a hybrid approach, allowing parties to execute a stock sale for legal and corporate purposes while treating it as an asset sale for federal income tax purposes.

Specifically, when a Section 338(h)(10) election is made, the Internal Revenue Service (IRS) disregards the actual stock transaction and instead treats the following as having occurred:

The target corporation (referred to as the “old target”) is deemed to have sold all of its assets to a new corporation (the “new target”) at fair market value in a single transaction.
Immediately after the deemed asset sale, the “old target” is deemed to have liquidated, distributing the proceeds from the deemed asset sale to its shareholders.

This recharacterization has profound tax implications for both the buyer and the seller, primarily by allowing the buyer to obtain a stepped-up basis in the acquired assets, which can lead to increased depreciation and amortization deductions in future tax periods. For the seller, it means recognizing gain or loss on the deemed asset sale rather than on the stock sale.

Who Qualifies for the C-Corp Section 338(h)(10) Election?

Not all corporate acquisitions are eligible for a Section 338(h)(10) election. Specific criteria must be met for both the target corporation and the purchasing corporation:

Qualified Stock Purchase (QSP): The purchasing corporation must make a QSP of the target corporation. A QSP occurs when a corporation acquires at least 80% of the total voting power and at least 80% of the total value of the stock of another corporation within a 12-month acquisition period. Preferred stock (as defined in Section 1504(a)(4)) is generally excluded from this calculation.
Eligible Target Corporation: The target corporation must be either:

A member of a consolidated group.
A member of an affiliated group that does not file a consolidated return.
An S corporation. (While the prompt specifies C-Corp, it\'s important to note the S-Corp eligibility as it\'s a common application of 338(h)(10)).

Purchasing Corporation: The buyer must be a corporation. Individuals, partnerships, or other non-corporate entities cannot make a Section 338(h)(10) election.
Joint Election: Both the purchasing corporation and the selling consolidated group (or the selling affiliate or S corporation shareholders) must jointly make the election. This mutual agreement is crucial, as the election impacts the tax liabilities of both parties.

How to Claim the C-Corp Section 338(h)(10) Election

The election is made by filing IRS Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases. Here’s a general overview of the process:

Agreement: The purchasing corporation and the selling group (or S corporation shareholders) must agree to make the Section 338(h)(10) election. This agreement is typically part of the acquisition agreement.
Form 8023 Filing: Form 8023 must be filed by the 15th day of the 9th month beginning after the month in which the acquisition date occurs. For example, if the acquisition date is June 15, 2026, the deadline for filing Form 8023 would be March 15, 2027.
Information Required: Form 8023 requires detailed information about the purchasing corporation, the target corporation, the acquisition date, and the stock acquired.
Asset Allocation: Although not filed with Form 8023, both the buyer and seller must generally file Form 8883, Asset Allocation Statement Under Section 338, to report how the purchase price is allocated among the acquired assets. This allocation is critical as it determines the basis of the assets for the buyer and the gain or loss recognized by the seller on the deemed asset sale. The allocation must be consistent between both parties.
Tax Returns: The tax consequences of the deemed asset sale and liquidation are reported on the respective tax returns of the selling group (or S corporation shareholders) and the purchasing corporation.

2026 Limits, Amounts, or Rates for Section 338(h)(10) Election

As of the current understanding for the 2026 tax year, there are no specific statutory limits or rates directly tied to the Section 338(h)(10) election itself. The election primarily recharacterizes a transaction for tax purposes, and the resulting tax liabilities are then subject to the general corporate and individual income tax rates and rules in effect for 2026. However, several factors indirectly influence the financial impact of the election:

Corporate Tax Rates: The corporate income tax rate (currently a flat 21% under the Tax Cuts and Jobs Act of 2017) will apply to any gain recognized by the target corporation on the deemed asset sale.
Capital Gains Rates: For individual shareholders of an S corporation target, the deemed liquidation proceeds would be subject to individual capital gains rates, which can vary based on income levels.
Depreciation and Amortization: The stepped-up basis in assets allows for increased depreciation and amortization deductions. The specific recovery periods and methods (e.g., MACRS for tangible assets, 15-year amortization for goodwill and certain intangibles under Section 197) will apply based on the nature of the assets.
Section 197 Intangibles: Goodwill and certain other intangible assets acquired in a Section 338(h)(10) transaction are generally amortizable over 15 years.
State and Local Taxes: The tax treatment of a Section 338(h)(10) election can vary significantly at the state and local levels. Some states may conform to the federal treatment, while others may not, potentially leading to different tax outcomes.
No significant changes for 2026 directly impacting 338(h)(10) election mechanics or rates have been announced. The general principles and requirements are expected to remain consistent with prior years.

Common Mistakes That Cost Taxpayers Money

Despite its benefits, the Section 338(h)(10) election is complex, and errors can lead to significant tax disadvantages. Common mistakes include:

Failure to Meet QSP Requirements: Not ensuring that the acquisition qualifies as a Qualified Stock Purchase (e.g., failing to acquire 80% of the stock within the 12-month period).
Inconsistent Asset Allocation: The buyer and seller must agree on the allocation of the purchase price among the assets. Inconsistent allocations reported on Form 8883 can trigger IRS scrutiny and potential adjustments.
Missing Filing Deadlines: Failing to file Form 8023 by the prescribed deadline can result in the election being invalid, forcing the transaction to be treated as a stock sale for tax purposes, which may be disadvantageous for the buyer.
Ignoring State and Local Tax Implications: Assuming state and local tax treatment will mirror federal treatment can lead to unexpected tax liabilities. It’s crucial to analyze the state-specific rules regarding Section 338(h)(10) elections.
Inadequate Due Diligence: Failing to thoroughly assess the target company’s tax history, potential liabilities, and asset composition before making the election.
Lack of Communication Between Parties: The joint nature of the election necessitates clear and continuous communication between the buyer and seller regarding the election decision, asset allocation, and filing responsibilities.
Not Considering the Seller’s Tax Burden: Buyers often benefit more from the election, but sellers may incur a higher tax burden (e.g., ordinary income on certain assets). Failing to negotiate appropriate compensation for the seller’s increased tax cost can complicate or derail the deal.

IRS Code Section Reference

The primary Internal Revenue Code section governing this election is Section 338, specifically Section 338(h)(10). Related regulations, such as Treasury Regulations Section 1.338(h)(10)-1, provide further guidance on the qualification and mechanics of the election.

Maximize Your Tax Strategy

The C-Corp Section 338(h)(10) election can be a powerful tool for optimizing tax outcomes in corporate acquisitions. However, its complexity demands careful planning and expert guidance. Understanding the nuances of this election, from eligibility to asset allocation and potential pitfalls, is crucial for both buyers and sellers to maximize their financial benefits and avoid costly mistakes. Don\'t navigate these intricate tax strategies alone.

Book a consultation with Uncle Kam\'s experienced tax strategists today to ensure your business transactions are structured for optimal tax efficiency and compliance. Book a Call at KDA Inc.

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C Corp Section 338 Election