What’s a Section 338(h)(10) election and why might a company want to use it in an M&A deal?

A Section 338(h)(10) election blends the benefits of a stock purchase and an asset purchase:

• Legally it is a stock purchase, but accounting-wise it’s treated like an asset purchase.

• The seller is still subject to double-taxation – on its assets that have appreciated and on the proceeds from the sale.

• But the buyer receives a step-up tax basis on the new assets it acquires, and it can depreciate/amortize them so it saves on taxes.  

Even though the seller still gets taxed twice, buyers will often pay more in a 338(h)(10) deal because of the tax-savings potential. It’s particularly helpful for:

• Sellers with high NOL balances (more tax-savings for the buyer because this NOL balance will be written down completely – and so more of the excess purchase price can be allocated to asset write-ups).

• If the company has been an S-corporation for over 10 years – in this case it doesn’t have to pay a tax on the appreciation of its assets.

The requirements to use 338(h)(10) are complex and bankers don’t deal with this – that is the role of lawyers and tax accountants.