Often times, a purchaser of a business prefers to acquire the assets of the target corporation rather than the stock of the target corporation, in order to “step-up” the basis of the assets, resulting in the ability to accelerate basis recovery primarily through depreciation and amortization on the stepped up basis. In many situations, an asset purchase is not feasible from a business point of view and the stock of the target corporation must be purchased. In order to give the parties to the transaction the option of treating a stock acquisition as an asset purchase, Section 338(h)(10) was enacted in 1982. If a Section 338(h)(10) election is made, the sale of stock is ignored and the transaction is treated as a deemed sale of assets by the corporation followed by a deemed liquidation of the corporation. A fictional “new corporation” is treated as purchasing the assets for their fair market value. In order for the election to be available, at least 80 percent of the vote and value of the target stock must be purchased during a 12 month period. However, a Section 338(h)(10) election can only be made if the target corporation is an S corporation or a corporate subsidiary of a consolidated group and the purchaser is a single corporation.
Enter Section 336(e)
In 1986, Section 336(e) was enacted to prevent certain situations in which a “triple tax “might arise. The code itself directed the Secretary of the Treasury to issue regulations that provide that a Section 336(e) election can be made to treat the sale, exchange or distribution of at least 80 percent of the stock of a target corporation as a sale of its underlying assets.
In 2013, 27 years after enactment, the Treasury Department issued regulations under Section 336(e) and in doing so greatly expanded the ability of taxpayers to take advantage of it. The provisions are similar to Section 338(h)(10), in that if a Section 336(e) election is made, the sale of stock is ignored and the transaction is treated as a deemed sale of assets by the corporation followed by a deemed liquidation of the corporation. The fictional “new corporation” also is treated as purchasing the assets for their fair market value.
The election is available to any domestic corporation or shareholder(s) of an S corporation that sell, exchange or distribute at least 80 percent of the vote and value of a target corporation to an unrelated party during a 12 month period. The purchaser is NOT required to be a single corporation, but can be an individual or a partnership. In fact, there may be multiple purchasers. As in the case of a Section 338(h)(10) election, neither the seller or target can be foreign. A notable difference is that the Section 336(e) election is made by the seller and target corporation, whereas in a Section 338(h)(10) election, the purchaser must agree and join in the election. In both cases, when an S corporation is involved, all S corporation shareholders must join in the election, not just those selling their stock.
Using a Section 336(e) provides additional planning opportunities for a purchaser, such as a private equity firm, to obtain a step-up in basis in the assets along with the resulting tax benefits, when a direct asset purchase is unavailable and a Section 338(h)(10) election cannot be made due to the technical requirements under that code section.
If you would like any further information please contact your Citrin Cooperman advisor.
Shawn M. Howard is a tax partner and co-practice leader of the firm’s Government Contracting Practice. He has extensive experience providing various tax services including the review of federal and multi-state tax returns, and tax strategies for a variety of domestic and international clients, including government contractors, professional services firms, technology companies, and private equity firms. He can be reached at 301-834-2489 or via email at firstname.lastname@example.org