How a Section 338 Election Works
A Section 338 election generally applies when a corporation acquires at least 80% of the target corporation's voting power and value in a qualified stock purchase during the applicable acquisition period. For federal income tax purposes, the target is generally treated as selling its assets and then as a new corporation acquiring those assets.
This creates two important tax concepts: the old target, which is treated as disposing of its assets, and the new target, which is treated as acquiring those assets with a new tax basis. The deemed asset sale can affect depreciation, amortization, gain recognition, and the allocation of the purchase price among the target's assets.
- Qualified stock purchase: The buyer must satisfy the statutory ownership requirements for the target's stock.
- Deemed asset sale: The target is treated as selling its assets for federal tax purposes.
- New tax basis: The deemed acquisition can establish a new basis in the target's assets.
- Election filing: The parties must follow the applicable election and reporting procedures.
Section 338(g) and Section 338(h)(10)
Section 338(g) is generally an election made by the purchasing corporation. It can apply to a qualifying stock purchase of an eligible target and generally treats the target as having sold its assets and then acquired them again as a new corporation. The tax consequences of the deemed sale are generally taken into account at the target level.
Section 338(h)(10) has different eligibility and consent requirements. It can apply to certain acquisitions of S corporations and targets that are members of a consolidated group or affiliated group. The election generally causes the target's assets to be treated as sold while providing a corresponding treatment for the target's stock transaction.
The distinction matters because the two elections can produce different consequences for the buyer, seller, target, tax attributes, and transaction economics. The parties therefore need to determine the applicable election before modeling the transaction's tax effects.
Tax Basis and Purchase Price Allocation
A central feature of a Section 338 Election is the treatment of the target's assets as having a new tax basis. The purchase price is allocated among the target's assets under the applicable tax allocation rules. This allocation can affect future depreciation and amortization deductions and the timing of taxable income.
For example, assume a buyer acquires a corporation for $10 million in a transaction eligible for a Section 338 election. If the resulting deemed asset purchase allocates $4 million to depreciable equipment, $3 million to identifiable intangible assets, and $3 million to other assets, those allocations establish the framework for determining the relevant tax bases and future deductions.
The asset allocation therefore becomes an important part of transaction modeling. Valuation work, tax due diligence, purchase agreements, and tax-return reporting should be aligned with the allocation used for the deemed transaction.
Business and Financial Implications
A Section 338 Election can influence the after-tax value of an acquisition because the buyer may receive tax basis consequences associated with an asset acquisition while legally purchasing stock. The resulting tax deductions and recognition of gains can affect transaction cash flows, purchase-price negotiations, and projected financial performance.
Finance teams should also distinguish Section 338 from other tax elections. A Section 754 Election, for example, generally addresses partnership basis adjustments and is not the mechanism used to characterize a qualifying corporate stock purchase as a deemed asset acquisition.
Likewise, 501h Election Finance concerns an election framework for eligible tax-exempt organizations and is separate from the corporate acquisition rules under Section 338. A Tax Detail Section may provide supporting information within a broader tax or finance workflow, but it does not replace the statutory Section 338 election.
Practical Considerations
Before making the election, transaction teams typically analyze the target's asset values and tax bases, liabilities, tax attributes, ownership structure, and the resulting tax consequences for each party. The buyer and seller may have different economic interests because an increased asset basis can provide future deductions for the buyer while the deemed asset sale can generate taxable gains for the seller or target.
Documentation is equally important. The election requires compliance with applicable filing rules, deadlines, consents, and allocation procedures. The transaction agreement should also clearly address who is responsible for preparing the election documents, determining purchase-price allocations, filing tax returns, and handling related tax adjustments.
Summary
Section 338 Election provides a federal tax mechanism for treating certain qualifying corporate stock acquisitions as deemed asset acquisitions. Section 338(g) and Section 338(h)(10) have different eligibility and tax consequences, making transaction structure and ownership important to the analysis. Understanding the election helps finance and tax teams evaluate asset basis, purchase-price allocation, future deductions, tax liabilities, cash flow, and the overall economics of a corporate acquisition.