338(h)(10) Election vs. Asset Sale:
The Tax Tool That Breaks Deal Impasses

A Section 338(h)(10) election is a joint tax election under the Internal Revenue Code that allows the parties to a qualified stock purchase to treat the transaction as an asset sale for federal income tax purposes, even though the legal transaction is a stock purchase. The buyer gets the tax benefits of an asset purchase - stepped-up basis in the target's underlying assets, enabling greater depreciation and amortization deductions. The transfer mechanics of a stock purchase are preserved - no need to individually assign contracts, permits, or licenses. Both the buyer and seller must jointly elect this treatment by filing IRS Form 8023 on or before the due date of the buyer's tax return for the year of the transaction.

The 338(h)(10) election is available for: (1) acquisitions of S-corporation stock - the most common use case; (2) acquisitions of stock in a target that is a member of a seller's consolidated group (i.e., a corporate subsidiary being sold by a parent in a consolidated return); and (3) certain foreign acquisitions. It is NOT available for standalone C-corporation stock purchases - in that scenario, the Section 338(g) election (a unilateral buyer election) is available but applies different tax mechanics. For most middle-market acquisitions involving S-corps, the 338(h)(10) election is the most important tax planning tool available.

The seller bears additional tax cost. In a straight stock sale of an S-corp, the selling shareholders recognize capital gain on the sale of their stock - typically the most tax-efficient outcome for the seller. With a 338(h)(10) election, the sale is treated as if the corporation sold all its assets, which means: (1) gain on each asset class is recognized (some asset classes have less favorable tax treatment than capital gain on stock), (2) depreciation recapture may be triggered (ordinary income), and (3) the gain flows through to the S-corp shareholders who report it on their individual returns. Sellers often demand a 'tax gross-up' payment from the buyer to compensate for the incremental tax cost of the election. The buyer benefits from the stepped-up basis; the additional cost is a negotiated payment that effectively splits the tax benefit.

Sellers agree to 338(h)(10) elections when the buyer's tax benefit is large enough to fund a meaningful gross-up payment that leaves the seller economically whole (or better) versus a pure stock sale with no election. This is the most common use of the election: the buyer's stepped-up basis creates future depreciation and amortization deductions worth, say, $1M in NPV. The buyer and seller split the benefit - buyer pays seller an additional $500K gross-up; buyer captures $500K of tax benefit net. Both parties leave money on the table relative to their optimal unilateral outcome, but both are better off than if the deal had not happened at all. The election is fundamentally a value-creation tool that good M&A counsel uses to close deals that would otherwise fail on structure.

The election requires mutual agreement and joint filing - it cannot be made unilaterally by either party. A buyer who wants the election must negotiate it with the seller, and the parties must agree on any gross-up payment to compensate the seller for incremental tax cost. If the seller refuses, the only unilateral option for the buyer is a Section 338(g) election, which treats the acquisition as if the target sold its assets but does not allow the tax benefits to flow through as cleanly to shareholders. For S-corp acquisitions, Section 338(g) is generally not available or not beneficial - the 338(h)(10) is the specific tool for this structure, and both parties must agree.