Corporate Tax | Just Tax

Stock Acquisition Election Analysis (§§ 338(g), 338(h)(10), 336(e))

This checklist guides practitioners through the election, computation, and reporting requirements when a stock acquisition is treated as a deemed asset sale under § 338(g), § 338(h)(10), or § 336(e). It covers all three elections from initial qualification through final documentation and should be used whenever a purchaser or seller seeks a stepped-up (or stepped-down) basis in target corporation assets following an acquisition or disposition of corporate stock.

Step 1. Overview and Statutory Framework

§ 338(a) provides that if an election under this section is made, then in the case of any qualified stock purchase, for purposes of this subtitle the target corporation—(1) shall be treated as having sold all of its assets at the close of the acquisition date at fair market value in a single transaction, and (2) shall be treated as a new corporation which purchased all of the assets referred to in paragraph (1) at the beginning of the day following the acquisition date.

Step 1A. The Three Election Regimes

• The § 338(g) regular election. This election is made unilaterally by the purchasing corporation following a qualified stock purchase (§ 338(g)(1) (authorizing the purchasing corporation to elect § 338(a) treatment for any QSP)). The purchasing corporation bears the tax cost of the deemed asset sale gain because old target recognizes gain on the deemed sale (§ 338(a)(1) (requiring old target to recognize gain or loss on the deemed asset sale at the close of the acquisition date)).
• The § 338(h)(10) joint election. This election is available when the target is acquired from a selling consolidated group, a selling affiliate, or S corporation shareholders (§ 338(h)(10) (extending § 338 treatment to acquisitions from specified sellers without requiring a QSP)). The seller generally bears the tax cost of the deemed asset sale (Treas. Reg. § 1.338(h)(10)-1(c)(1) (providing that the selling consolidated group, selling affiliate, or S corporation shareholders make the joint election with the purchasing corporation and generally bear the tax consequences)).
• The § 336(e) seller-driven election. This election is available for qualified stock dispositions (§ 336(e) (authorizing the Secretary to prescribe regulations under which a disposition of stock may be treated as a sale of target assets)). No corporate purchaser is required and any person may be the purchaser (Treas. Reg. § 1.336-1(b)(2) (providing that the purchaser in a QSD may be any person including individuals, partnerships, LLCs, corporations, or foreign entities)). The seller and target make the election jointly (Treas. Reg. § 1.336-2(h) (requiring a joint election by seller and target corporation)).

Step 1B. Common Policy Objective and Divergent Mechanics

• Stepped-up or stepped-down basis in target assets. All three elections provide for a new basis in the target corporation's assets equal to the consideration paid (or deemed paid) for the stock (§ 338(b)(1) (defining AGUB as the basis of assets in new target). Treas. Reg. § 1.336-2(b) (providing that target's basis in assets is adjusted pursuant to a § 336(e) election)). This basis step-up can generate additional depreciation and amortization deductions for the post-acquisition period.
• Variations in tax cost allocation. Under § 338(g), the purchasing corporation effectively bears the tax cost because old target pays the tax on deemed sale gain before the stock purchase proceeds are distributed (§ 338(a)(1) (treating old target as selling all assets and recognizing gain)). Under § 338(h)(10), the selling consolidated group or S corporation shareholders generally bear the tax cost (Treas. Reg. § 1.338(h)(10)-1(c)(1) (allocating tax consequences to the seller)). Under § 336(e), the seller bears the tax cost through recognition of gain or loss on the deemed asset sale (Treas. Reg. § 1.336-2(b) (treating target as selling its assets and recognizing the tax consequences)).
• Purchaser identity requirements. § 338(g) and § 338(h)(10) both require a corporate purchaser (Treas. Reg. § 1.338-3(b) (requiring a purchasing corporation). § 338(h)(10) (requiring acquisition by another corporation)). § 336(e) imposes no such requirement and permits any purchaser (Treas. Reg. § 1.336-1(b)(2) (permitting any person to be the purchaser in a QSD)).

Step 1C. Mutual Exclusivity and Election Hierarchy

• The § 338(h)(10) priority rule over § 336(e). If a transaction could satisfy both the QSD and QSP requirements (including the requirements for a § 338(h)(10) election), § 338 rules take precedence and the transaction is NOT treated as a QSD (Treas. Reg. § 1.336-1(b)(6)(ii)(A) (providing that a transaction described in both § 338(d)(3) and Treas. Reg. § 1.336-1(b)(6)(i) is treated as a QSP and not a QSD)). A corporate purchaser making a QSP cannot elect § 336(e) in lieu of § 338.
  • Subsidiary deemed sale exception. This priority rule does not apply to prevent a subsidiary deemed asset sale under § 336(e) (Treas. Reg. § 1.336-1(b)(6)(ii) (carving out subsidiary deemed asset sales from the QSP-priority rule)). A subsidiary of target may still have a deemed asset sale under § 336(e) even if the parent-level transaction is treated as a QSP.
• Election interaction between § 338(g) and § 338(h)(10). A transaction eligible for § 338(h)(10) may not simultaneously be subject to a § 338(g) election because § 338(h)(10) operates as a modality of § 338 itself (§ 338(h)(10) (treating specified acquisitions as qualified stock purchases for purposes of § 338)). Once the parties jointly elect § 338(h)(10), the unilateral § 338(g) election is unavailable for that transaction.
  • Practical sequencing. Determine first whether § 338(h)(10) is available and desired. If YES → § 338(h)(10) joint election is made and § 338(g) is foreclosed. If NO (e.g., seller is not a consolidated group, affiliate, or S corporation) → evaluate whether a § 338(g) election is available (cross-reference Step 2 and Step 4). If NO corporate purchaser exists → evaluate § 336(e) (cross-reference Step 3).

Step 2. Qualified Stock Purchase Requirements Under § 338

Step 2A. The 80-Percent Voting Power and Value Threshold

• The § 1504(a)(2) control standard. A QSP is defined as any transaction or series of transactions in which stock meeting the requirements of § 1504(a)(2) is acquired by another corporation by purchase during a 12-month acquisition period (§ 338(d)(3) (defining QSP by incorporating the § 1504(a)(2) control test)). This requires acquisition of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total value of shares of all classes of stock (§ 1504(a)(2)(A) and (B) (stating separate voting power and value requirements)). Both the 80-percent voting power test and the 80-percent value test must be satisfied.
  • Voting power vs. value distinction. The voting power test looks to voting rights rather than economic rights. Nonvoting preferred stock does not count toward the voting power test but may count toward the value test unless it falls within the § 1504(a)(4) exception (§ 1504(a)(2)(A) (testing voting power) and § 1504(a)(2)(B) (testing value)).
  • Aggregation across multiple transactions. Stock acquired in separate transactions during the 12-month acquisition period is aggregated to determine whether the 80-percent threshold is met (§ 338(h)(1) (defining acquisition period and requiring aggregation of stock acquired by purchase during such period)).

Step 2B. The "Purchase" Requirement and Excluded Acquisitions

• Definition of purchase under § 338(h)(3). A "purchase" for QSP purposes means any acquisition of stock but only if three conditions are satisfied (§ 338(h)(3) (defining purchase by exclusion)). If any of the three prohibitions applies, the acquisition is not a purchase and does not count toward the 80-percent threshold.
  • (i) The substituted basis prohibition. The basis of the acquired stock in the purchaser's hands must not be determined by reference to the adjusted basis of such stock in the hands of the person from whom acquired or under § 1014(a) (relating to property acquired from a decedent) (§ 338(h)(3)(A)(i) (excluding carryover basis acquisitions and stepped-up basis acquisitions from a decedent)). This prevents tax-free transfers and inherited stock acquisitions from counting as purchases.
  • (ii) The nonrecognition exchange prohibition. The stock must not be acquired in an exchange to which § 351 (transfers to controlled corporations), § 354 (stock-for-stock exchanges in reorganizations), § 355 (distributions of stock), or § 356 (receipt of other property in reorganizations) applies (§ 338(h)(3)(A)(ii) (excluding nonrecognition transactions from the definition of purchase)). Acquisitions in such exchanges are not purchases.
  • (iii) The related party prohibition. The stock must not be acquired from a person whose stock ownership would be attributed to the purchaser under § 318(a) other than § 318(a)(4) relating to options (§ 338(h)(3)(A)(iii) (excluding acquisitions from related persons)). For this purpose, option attribution under § 318(a)(4) is disregarded in determining related party status.
• Basis determination in ordinary acquisitions. Stock acquired for cash clearly satisfies the basis requirement. Stock acquired in exchange for notes or other consideration generally satisfies the requirement so long as basis is not determined by reference to the transferor's adjusted basis (§ 338(h)(3)(A)(i) (requiring independent basis determination)).

Step 2C. The Purchasing Corporation Requirement

• Only corporations can be purchasing corporations. The entity acquiring the target stock must be a corporation to have a QSP (Treas. Reg. § 1.338-3(b) (requiring the purchasing corporation to be a corporation as defined in § 7701(a)(3))). An individual, partnership, or LLC taxed as a partnership cannot directly make a QSP.
  • Workaround through NewCo formation. A noncorporate buyer can form a new corporation (NewCo) to acquire target stock and satisfy the purchasing corporation requirement (Treas. Reg. § 1.338-3(b) (implicitly allowing indirect qualification through a corporate acquisition vehicle)). NewCo then makes the § 338(g) election as the purchasing corporation.
• LLC classified as a corporation. An LLC that has elected to be classified as a corporation under the check-the-box regulations may serve as the purchasing corporation (Treas. Reg. § 301.7701-3 (permitting eligible entities to elect corporate classification)). This election must be in effect at the time of the stock acquisition.
  • Entity classification timing. If the purchasing entity is an LLC, confirm that its corporate classification election under Treas. Reg. § 301.7701-3 is effective on or before the date of the first purchase of target stock. If the election is not effective → the acquisition does not qualify as a QSP.

Step 2D. The 12-Month Acquisition Period and Acquisition Date

• The acquisition period. The 12-month acquisition period is the period during which the purchasing corporation must acquire the requisite 80 percent of target stock by purchase (§ 338(h)(1) (defining acquisition period as the 12-month period beginning on the date of the first acquisition by purchase of stock included in a qualified stock purchase)). The period begins on the date of the first purchase of target stock and runs for 12 consecutive months.
  • Disaggregation rule. If stock is acquired in a purchase and later disposed of during the acquisition period, the disposed stock is disregarded in determining whether the 80-percent threshold is met (Treas. Reg. § 1.338-3(d) (providing disaggregation rules for stock disposed of during the acquisition period)). Only stock still held at the time the threshold is tested counts toward the 80-percent requirement.
• The acquisition date. The acquisition date is the first day on which there is a qualified stock purchase (§ 338(h)(2) (defining acquisition date as the first day there is a QSP)). This is the first day the 80-percent threshold is satisfied (Treas. Reg. § 1.338-3(c) (defining acquisition date as the first date the purchasing corporation acquires by purchase 80 percent of target stock)). The deemed asset sale occurs at the close of this date (§ 338(a)(1)).
  • Significance of the acquisition date. The acquisition date determines the timing of the deemed sale, the measuring date for asset fair market value, and the deadline for filing the election (Treas. Reg. § 1.338-2(d) (tying the Form 8023 filing deadline to the 15th day of the 9th month beginning after the month of the acquisition date)).

Step 2E. Affiliated Group Aggregation and Related Party Rules

• Affiliated group members treated as one corporation. All members of the same affiliated group as defined in § 1504(a) without regard to § 1504(b) are treated as one corporation for purposes of determining whether a QSP has occurred (§ 338(b)(8) (requiring aggregation of acquisitions by all members of the purchasing corporation's affiliated group)). Stock acquired by multiple members of the same affiliated group is aggregated.
  • Scope of the affiliated group definition. For purposes of § 338(b)(8), the affiliated group definition in § 1504(a) applies without the exclusions in § 1504(b) (such as the exclusion for certain foreign corporations and tax-exempt organizations) (§ 338(b)(8) (incorporating § 1504(a) without the § 1504(b) exclusions)). This produces a broader affiliated group than for consolidated return purposes.
• Related party acquisitions excluded from the 80-percent test. Stock acquired from a related person under § 318(a) (excluding § 318(a)(4) options attribution) does not count toward the 80-percent threshold (§ 338(h)(3)(A)(iii) (excluding acquisitions from related persons)). This prevents a purchaser from using related parties to manufacture a QSP.
  • Attribution rules applied. For this purpose, § 318(a) attribution applies including family attribution under § 318(a)(1), entity-to-owner attribution under § 318(a)(2), owner-to-entity attribution under § 318(a)(3), but excluding option attribution under § 318(a)(4) (§ 338(h)(3)(A)(iii) (specifying the applicable attribution rules)).

Step 2F. Preferred Stock and Special Stock Rules

• § 1504(a)(4) preferred stock exclusion. Stock described in § 1504(a)(4) (nonvoting, nonparticipating, limited and preferred as to dividends and liquidation, and not redeemable at the option of the holder) is excluded from both the voting power and value computations for the 80-percent test (Treas. Reg. § 1.338-3(b)(2) (excluding § 1504(a)(4) stock from the control computation)). Such stock is treated as if it were not outstanding.
  • Impact on voting power and value tests. Because § 1504(a)(4) stock is excluded entirely, it does not count as outstanding stock for either the numerator or the denominator of the 80-percent tests (Treas. Reg. § 1.338-3(b)(2)). This can alter the percentage calculation significantly depending on the target's capital structure.
• Stock options and convertible securities. Options and convertible securities are generally not treated as stock for the 80-percent test until exercised or converted (Treas. Reg. § 1.338-3(b)(3) (providing rules for treating certain options and convertible securities as stock)). If an option is treated as stock under general tax principles or under specific regulatory rules, it may be counted as outstanding.

Step 2G. Creeping Acquisition Concerns

• Prior ownership and the 80-percent computation. Stock owned by the purchasing corporation before the first purchase in the acquisition period is not counted toward the 80-percent threshold (Treas. Reg. § 1.338-3(b) and (c) (counting only stock acquired by purchase during the acquisition period)). The test looks only to what is acquired by purchase during the 12-month acquisition period.
  • Creeping acquisitions and threshold planning. If the purchaser already owns target stock before the acquisition period begins, only additional stock acquired by purchase during the acquisition period counts. The prior-owned stock is effectively neutral (not added to the numerator, not subtracted from the denominator). This can make it harder to reach 80 percent if significant nonqualifying stock is already held.
• CAUTION. A creeping acquisition can destroy § 338(h)(10) eligibility. Once a purchaser acquires more than 20 percent of target stock (outside a QSP or otherwise), the target may deconsolidate from the selling group (if the selling group drops below 80-percent ownership) or may lose S corporation status (if the purchaser is an ineligible shareholder such as a corporation in the case of an S corporation target) (Treas. Reg. § 1.338(h)(10)-1(c)(1) (requiring target to be a member of the selling consolidated group or an S corporation at the time of acquisition)). This can destroy eligibility for a § 338(h)(10) election before a QSP is even attempted.
  • Planning implication for sellers. Sellers seeking a § 338(h)(10) election should avoid any pre-QSP stock transfers to the purchaser that would cause the target to fall out of the selling group or terminate S corporation status. Even a small pre-QSP transfer to an ineligible holder can be fatal.

Step 3. Qualified Stock Disposition Requirements Under § 336(e)

Step 3A. The General QSD Definition

• Definition of qualified stock disposition. A QSD is any transaction or series of transactions in which stock meeting the requirements of § 1504(a)(2) of a domestic corporation is sold, exchanged, or distributed (or any combination thereof) during a 12-month disposition period (Treas. Reg. § 1.336-1(b)(6)(i) (defining QSD by reference to § 1504(a)(2) and requiring dispositions during a 12-month period)). This definition closely parallels the QSP definition but uses the broader concept of "disposition" rather than "purchase."
  • The 80-percent threshold. Like the QSP, the QSD requires that stock possessing at least 80 percent of the total combined voting power and at least 80 percent of the total value of the target be disposed of during the 12-month period (Treas. Reg. § 1.336-1(b)(6)(i) (incorporating the § 1504(a)(2) control standard)). Both tests must be satisfied.
  • Multiple disposition types allowed. The 80-percent threshold can be satisfied through any combination of sales, exchanges, and distributions (Treas. Reg. § 1.336-1(b)(6)(i) (permitting mixed disposition types including sales, exchanges, and distributions in any combination)).

Step 3B. The "Disposition" Requirement

• Definition of disposition. A disposition means any transfer of stock in a transaction where the following conditions are satisfied (Treas. Reg. § 1.336-1(b)(5) (defining disposition by exclusion)).
  • (1) The basis determination requirement. The basis of the stock in the transferee's hands is not determined by reference to the adjusted basis of the stock in the transferor's hands and is not determined under § 1014(a) (property acquired from a decedent) or § 1022 (basis of property acquired from a decedent dying in 2010) (Treas. Reg. § 1.336-1(b)(5)(i) through (iii) (excluding carryover basis acquisitions, stepped-up basis acquisitions from a decedent, and basis determined under § 1022)).
  • (2) The nonrecognition transaction exclusion. The stock is not acquired in a nonrecognition transaction to which § 351, § 354, § 355, or § 356 applies (Treas. Reg. § 1.336-1(b)(5)(iv) (excluding nonrecognition transactions)). This parallels the § 338(h)(3)(A)(ii) exclusion for purchases.
• Comparison to "purchase" under § 338. The disposition definition is broader than the purchase definition in two key respects. First, it encompasses distributions (which are not purchases). Second, it does not include the related party prohibition that applies under § 338(h)(3)(A)(iii) (Treas. Reg. § 1.336-1(b)(5) (defining disposition without a related party exclusion)). However, dispositions to related persons are excluded from counting toward the 80-percent test under a separate rule in Treas. Reg. § 1.336-1(b)(12).

Step 3C. Seller and Target Eligibility

• Target must be a domestic corporation. The target in a QSD must be a domestic corporation (Treas. Reg. § 1.336-1(b)(3) (restricting target eligibility to domestic corporations)). Foreign corporations cannot be targets for a § 336(e) election.
  • Target subsidiary status. Target may be a subsidiary of the seller or may be directly owned by S corporation shareholders (Treas. Reg. § 1.336-2(a) (describing the sellers eligible to make a § 336(e) election including domestic corporations and S corporation shareholders)).
• Eligible sellers. The seller must be one of the following (Treas. Reg. § 1.336-1(b)(6)(i) and Treas. Reg. § 1.336-2(a) (specifying eligible sellers)).
  • (i) A domestic corporate seller owning 80 percent or more. A domestic corporation that owns stock meeting the requirements of § 1504(a)(2) in the target (Treas. Reg. § 1.336-2(a)(1) (providing that a domestic corporation that is the common parent of a consolidated group or a standalone domestic corporation may be a seller)).
  • (ii) Multiple consolidated group members owning 80 percent or more in the aggregate. Members of an affiliated group filing a consolidated return that collectively own 80 percent or more of target stock (Treas. Reg. § 1.336-2(a)(2) (permitting multiple consolidated group members to aggregate their ownership to satisfy the 80-percent requirement)).
  • (iii) S corporation shareholders owning 80 percent or more in the aggregate. Shareholders of an S corporation that collectively own 80 percent or more of target stock (Treas. Reg. § 1.336-2(a)(3) (permitting S corporation shareholders to be sellers and to aggregate their ownership)).
• TRAP. Partnerships or individuals disposing of C corporation stock generally CANNOT make a § 336(e) election. Unless the seller is a domestic corporation, a member of a consolidated group, or S corporation shareholders, no § 336(e) election is available (Treas. Reg. § 1.336-1(b)(6)(i) and Treas. Reg. § 1.336-2(a) (limiting eligible sellers to specified categories)). A partnership or individual selling C corporation stock cannot make the election unless the stock is treated as owned through an S corporation structure qualifying under Treas. Reg. § 1.336-2(a)(3).
  • Structure verification. If the seller is a partnership, check whether any partner is an S corporation and whether the stock is treated as owned by S corporation shareholders for purposes of Treas. Reg. § 1.336-2(a)(3). If NO such structure exists → the § 336(e) election is unavailable and the seller should consider other alternatives.

Step 3D. Related Person Exclusion

• Dispositions to related persons do not count. Dispositions to a related person under Treas. Reg. § 1.336-1(b)(12) do not count toward the 80-percent disposition test (Treas. Reg. § 1.336-1(b)(12) (excluding dispositions to related persons from the 80-percent computation)). This ensures that internal or related-party shifts of stock do not manufacture a QSD.
  • Related person definition. A related person is determined using the relationships specified in § 267(b) and § 707(b)(1) (Treas. Reg. § 1.336-1(b)(12) (incorporating § 267(b) and § 707(b)(1) related person definitions)). This includes family members, corporations and shareholders with 50-percent ownership, trusts and beneficiaries, and partners and partnerships.
  • Comparison to § 338 related party rule. The § 336(e) related person test uses § 267(b) and § 707(b)(1), which differs from the § 318(a) test used for § 338(h)(3)(A)(iii) (Treas. Reg. § 1.336-1(b)(12) (using different related person standards than § 338)). Under § 267(b), certain relationships such as brother-sister corporations are covered that may not be covered under § 318(a). Practitioners must analyze both tests separately when evaluating cross-election eligibility.

Step 3E. Overlap Between QSD and QSP

• QSP priority over QSD. If a transaction satisfies both the QSD and QSP requirements, § 338 rules take precedence and the transaction is NOT treated as a QSD (Treas. Reg. § 1.336-1(b)(6)(ii)(A) (providing that a transaction described in both § 338(d)(3) and Treas. Reg. § 1.336-1(b)(6)(i) is treated as a QSP and not a QSD)). A corporate purchaser making a QSP cannot use § 336(e) instead of § 338.
  • Subsidiary deemed sale exception. This priority rule does not apply to prevent a subsidiary deemed asset sale under § 336(e) (Treas. Reg. § 1.336-1(b)(6)(ii) (carving out subsidiary deemed asset sales from the QSP-priority rule)). A subsidiary of target can still have a deemed asset sale under § 336(e) even if the parent transaction is treated as a QSP.
• Decision framework for practitioners. If the purchaser is a corporation and all QSP requirements are satisfied (cross-reference Step 2), the transaction is a QSP regardless of whether it also meets QSD requirements. If YES (QSP satisfied and purchaser is a corporation) → the transaction is a QSP, not a QSD. If NO (QSP not satisfied, e.g., purchaser is not a corporation or purchase requirements not met) → evaluate whether QSD requirements are satisfied for a § 336(e) election.

Step 3F. The Disposition Date

• Disposition date defined. The disposition date is the first day there is a QSD (Treas. Reg. § 1.336-2(b) (defining disposition date as the first day there is a qualified stock disposition)). This concept parallels the acquisition date under § 338(h)(2).
  • Timing significance. The disposition date is the date on which target is treated as selling its assets and is also the measuring date for asset values and the relevant date for the § 336(e) election deadline (Treas. Reg. § 1.336-2(b) and (h) (tying the deemed sale timing and election filing to the disposition date)).

Step 3G. Purchaser Identity and Seller-Driven Election Mechanics

• Any person may be the purchaser. Unlike § 338, the § 336(e) election does not require a corporate purchaser. The purchaser may be an individual, partnership, LLC, corporation, domestic entity, or foreign entity (Treas. Reg. § 1.336-1(b)(2) (providing that the purchaser in a QSD may be any person)). This is a key advantage of § 336(e) over § 338.
  • No corporate purchaser requirement. This flexibility allows sellers to obtain a stepped-up basis for target assets even when the buyer is a noncorporate entity or foreign person that could not trigger a QSP (Treas. Reg. § 1.336-1(b)(2)). Cross-reference Step 2C for the corporate purchaser requirement under § 338.
• The election is seller-driven. The seller and target make the § 336(e) election jointly (Treas. Reg. § 1.336-2(h) (requiring a joint election by seller and target)). The purchaser's consent is NOT required (Treas. Reg. § 1.336-2(h) (not requiring purchaser consent for the election)). This stands in contrast to § 338(h)(10), which requires a joint election by the selling group and the purchasing corporation.
  • Timing of election. The election must be made by the seller and target by attaching a statement to their timely-filed federal income tax returns for the taxable year that includes the disposition date (Treas. Reg. § 1.336-2(h) (specifying the election filing requirements)). The statement must include specific information about the transaction.

Step 4. The § 338(g) Regular Election

§ 338(a) provides that if an election under this section is made, then in the case of any qualified stock purchase, for purposes of this subtitle the target corporation—(1) shall be treated as having sold all of its assets at the close of the acquisition date at fair market value in a single transaction, and (2) shall be treated as a new corporation which purchased all of the assets referred to in paragraph (1) at the beginning of the day following the acquisition date.

Step 4A. Election Mechanics and Filing

• Unilateral election by purchasing corporation. The § 338(g) election is made solely by the purchasing corporation. Seller consent is NOT required (§ 338(g)(1) (authorizing the purchasing corporation to elect § 338(a) treatment for any qualified stock purchase)). This gives the buyer complete control over whether to make the election and the seller has no statutory veto.
  • Form 8023 filing requirement. The election is made by filing Form 8023, Elections Under § 338 for Corporations Making Qualified Stock Purchases, by the 15th day of the 9th month beginning after the month in which the acquisition date occurs (Treas. Reg. § 1.338-2(d) (requiring Form 8023 filing within the prescribed deadline)). The form must include all required information including the identification of the purchasing corporation, the target corporation, and the acquisition date.
• Irrevocability of the election. The election is irrevocable once made (§ 338(g)(3) (providing that a § 338 election once made is irrevocable) and Treas. Reg. § 1.338-2(d) (confirming irrevocability)). The purchasing corporation cannot revoke the election after the filing deadline has passed.
  • Late election relief. Late election relief is available under the regulatory extension provisions in Treas. Reg. § 301.9100-1, Treas. Reg. § 301.9100-2, and Treas. Reg. § 301.9100-3 and Rev. Proc. 2003-33 (Treas. Reg. § 1.338-2(d) (referring to § 301.9100 relief) and Rev. Proc. 2003-33 (providing an automatic 12-month extension from the date the taxpayer discovers the failure to make a timely election)).
    • Automatic relief under Rev. Proc. 2003-33. Rev. Proc. 2003-33 provides automatic relief if the late election is filed within 12 months of the due date (excluding extensions) of the purchasing corporation's return for the taxable year that includes the acquisition date (Rev. Proc. 2003-33, § 4 (describing the automatic relief conditions including reasonable cause and good faith requirements)). The taxpayer must also have acted reasonably and in good faith.
    • Discretionary extension under Treas. Reg. § 301.9100-3. For relief beyond the automatic 12-month period, the taxpayer must request a private letter ruling under the standards of Treas. Reg. § 301.9100-3 (Treas. Reg. § 301.9100-3 (providing standards for granting discretionary extensions)). The taxpayer must demonstrate that it acted reasonably and in good faith and that granting relief will not prejudice the interests of the government.

Step 4B. Deemed Asset Sale and Purchase Mechanics

• Old target deemed sale. Target is treated as having sold all of its assets at the close of the acquisition date at fair market value in a single transaction (§ 338(a)(1) (treating old target as selling all assets at FMV at the close of the acquisition date)). This is a deemed asset sale for federal income tax purposes.
  • Taxable year of old target. The deemed sale occurs on the acquisition date and is included in old target's final tax return (§ 338(a)(1) and Treas. Reg. § 1.338-1(b)(1) (treating old target as a separate corporation through the close of the acquisition date)). Old target files a short-period return covering the period up to and including the acquisition date.
• New target deemed purchase. Target is treated as a new corporation that purchased all of the assets referred to in § 338(a)(1) at the beginning of the day following the acquisition date (§ 338(a)(2) (treating new target as purchasing all assets at the beginning of the day after the acquisition date)). This is a deemed asset purchase.
  • Continuity of EIN. New target keeps the same employer identification number (EIN) as old target (Treas. Reg. § 1.338-1(b)(3)(iii) (requiring new target to retain old target's EIN)). For all other tax purposes, new target is treated as a different taxpayer from old target with no succession to old target's tax attributes.

Step 4C. Tax Consequences for Old Target and New Target

• Old target recognizes gain or loss. Old target recognizes gain or loss on the deemed sale of its assets as if the assets had actually been sold to an unrelated party (§ 338(a)(1) (requiring gain or loss recognition on the deemed asset sale)). This is a separate tax at the corporate level computed on old target's final return.
  • Character of gain or loss. The character of the deemed sale gain or loss is determined as if the assets had actually been sold (Treas. Reg. § 1.338-1(b)(1) (applying general tax principles to determine character)). § 1231 gain, ordinary income recapture under § 1245 and § 1250, and collectibles gains are all computed in the normal manner.
• TRAP. Two levels of tax for standalone C corporations. For a standalone C corporation target, the § 338(g) election triggers TWO levels of tax. First, old target pays corporate-level tax on the deemed asset sale gain (§ 338(a)(1) (requiring old target to recognize gain)). Second, the selling shareholders pay shareholder-level tax on the stock sale proceeds (§ 1001 (requiring gain or loss recognition on the actual sale of stock)). This double tax burden is why § 338(g) is rarely used for domestic targets unless target has significant net operating losses to offset the deemed sale gain.
  • EXAMPLE. Target is a standalone C corporation with assets having an aggregate FMV of $100 and an aggregate adjusted basis of $40. Purchasing corporation acquires 100 percent of target stock for $100 and makes a § 338(g) election. Old target recognizes $60 of deemed asset sale gain at the corporate level (taxed at 21 percent, or $12.60). The selling shareholders recognize $60 of stock sale gain at the shareholder level (taxed at capital gains rates). New target takes a $100 basis in the assets (AGUB). Total tax cost is approximately $12.60 in corporate tax plus the shareholder-level capital gains tax. If target had $60 of NOLs, the corporate-level tax would be eliminated, making the § 338(g) election more attractive.
• Target not treated as member of purchasing corporation's affiliated group for deemed sale. Target is NOT treated as a member of any affiliated group that includes the purchasing corporation with respect to the deemed sale (§ 338(b)(9) (preventing old target from being included in the purchasing corporation's consolidated group for the deemed sale) and Treas. Reg. § 1.338-10 (providing rules for the interaction of § 338 with consolidated return regulations)). This prevents the purchasing corporation from offsetting the deemed sale gain with its own losses or NOLs.
  • Consolidated return implications. If purchasing corporation files a consolidated return, target does not join the consolidated group until the taxable year beginning after the acquisition date (Treas. Reg. § 1.338-10 (providing that new target may not join the purchasing corporation's consolidated group until the taxable year beginning after the acquisition date)). Old target's deemed sale gain is reported on a separate return.

Step 4D. Basis and Tax Attribute Consequences

• New target's basis is AGUB. New target's basis in the purchased assets is the adjusted grossed-up basis (AGUB) (§ 338(b)(1) (defining AGUB as the grossed-up basis of recently purchased stock plus liabilities of new target) and Treas. Reg. § 1.338-5 (providing detailed rules for computing AGUB)). AGUB is allocated among the assets under the residual method of § 1060 and Treas. Reg. § 1.338-6.
  • AGUB components. AGUB consists of (1) the grossed-up basis of recently purchased stock, (2) the basis of nonrecently purchased stock (if a gain recognition election is made under § 338(b)(3)), and (3) the liabilities of new target (§ 338(b) (defining AGUB components) and Treas. Reg. § 1.338-5 (detailing the AGUB computation methodology)).
  • Allocation under the residual method. AGUB is allocated first to Class I assets (cash and cash equivalents), then to Class II (actively traded personal property), Class III (accounts receivable and debt instruments), Class IV (inventory), Class V (all other assets except Class VI and VII), Class VI (§ 197 intangibles other than goodwill and going concern value), and Class VII (goodwill and going concern value) (Treas. Reg. § 1.338-6 (prescribing the residual method allocation of AGUB)).
• Old target's tax attributes generally do not survive. Old target's tax attributes including net operating losses, capital loss carryforwards, earnings and profits, and tax credit carryovers generally do NOT carry over to new target (Treas. Reg. § 1.338-1(b) (providing that new target does not succeed to old target's tax attributes)). New target starts with a clean slate.
  • Limited exceptions. Certain specific attributes may survive in limited circumstances. For example, new target may succeed to old target's method of accounting in certain cases (Treas. Reg. § 1.338-1(b)(2) (providing limited exceptions to the attribute non-succession rule)). However, NOLs and other loss attributes do not survive. The purchasing corporation must value target accordingly, as NOLs that appeared valuable on the balance sheet may vanish upon election.

Step 4E. Special Considerations for Foreign Targets and Foreign Purchasers

• TRAP. Foreign target with CFC status and Subpart F or GILTI implications. If target is a controlled foreign corporation (CFC) and the purchasing corporation is or becomes a U.S. shareholder, the deemed sale gain may trigger Subpart F income inclusions under § 951(a) or global intangible low-taxed income (GILTI) inclusions under § 951A (see The Tax Adviser, "§ 338 Elections for Foreign Targets," May 2024 (analyzing the interaction of § 338(g) elections with CFC status and the potential for deemed sale gain to be treated as Subpart F income or tested income for GILTI purposes)). This can result in immediate U.S. tax on the deemed sale gain even though the transaction is structured as a stock purchase.
  • Pre-acquisition U.S. shareholder status. The critical issue is whether the purchasing corporation was a U.S. shareholder of target before the acquisition date. If YES → the deemed sale gain may be treated as Subpart F income or tested income for GILTI purposes in the year of the acquisition. If NO → different analysis applies and the gain may not trigger immediate inclusion.
  • Planning consideration. Structure the acquisition to minimize CFC status during the acquisition period or evaluate whether a § 338(h)(10) election (if available) or other elections could avoid adverse CFC consequences. Model the GILTI and Subpart F impact before making the election.
• Foreign purchasing corporation rules. If the purchasing corporation is a foreign corporation, special rules apply to the § 338(g) election (Treas. Reg. § 1.338-2(e) (providing special rules for foreign purchasing corporations)). The regulations address the effect of the election on the foreign corporation's U.S. tax liability and the application of § 367.
  • Coordination with § 367. A § 338(g) election by a foreign purchasing corporation may trigger gain recognition under § 367 if the target holds U.S. real property interests or other assets that would be taxable on a direct transfer (Treas. Reg. § 1.338-2(e) (coordinating the § 338 election with § 367)). Careful analysis of § 367(b) and § 367(d) implications is required before a foreign purchaser makes the election.

Step 4F. Late Election Relief and Practical Considerations

• Automatic extension under Rev. Proc. 2003-33. The IRS provides an automatic 12-month extension for filing a late § 338(g) election under Rev. Proc. 2003-33 (Rev. Proc. 2003-33, § 3 (granting automatic relief for late § 338 elections)). To qualify, the taxpayer must (1) have timely filed the return for the year of the acquisition, (2) have acted reasonably and in good faith, and (3) satisfy the procedural requirements of the revenue procedure.
  • Discretionary extension under Treas. Reg. § 301.9100-3. For relief beyond the automatic 12-month period, the taxpayer must request a private letter ruling under the standards of Treas. Reg. § 301.9100-3 (Treas. Reg. § 301.9100-3 (providing standards for granting discretionary extensions including reasonable cause and prejudice to the government analysis)). The taxpayer must demonstrate that it acted reasonably and in good faith and that granting relief will not prejudice the interests of the government.
• Practical election coordination. The purchasing corporation should confirm with its tax advisors, the target's pre-acquisition shareholders, and any relevant consolidated group before making the election. Although seller consent is not required, the tax consequences for old target (and indirectly for sellers if target indemnifies the purchaser for pre-closing taxes) should be fully modeled.
  • Due diligence checklist before election. Before making the election, the purchasing corporation should confirm (1) that a QSP has occurred (cross-reference Step 2), (2) that old target's tax attributes are correctly computed and valued, (3) that no foreign tax or GILTI issues are triggered (cross-reference Step 4E), (4) that the AGUB computation is supportable, and (5) that the election filing deadline is calendared and met.

Step 5. The § 338(h)(10) Joint Election

Under regulations prescribed by the Secretary, an election may be made under which if— (i) the target corporation was, before the transaction, a member of the selling consolidated group, and (ii) the target corporation recognizes gain or loss with respect to the transaction as if it sold all of its assets in a single transaction, then the target corporation shall be treated as a member of the selling consolidated group with respect to such sale, and (to the extent provided in regulations) no gain or loss will be recognized on stock sold or exchanged in the transaction by members of the selling consolidated group. (§ 338(h)(10)(A))

The § 338(h)(10) election is the most commonly utilized election in subsidiary stock acquisitions and S corporation acquisitions. It permits a stock purchase to be treated as a deemed asset acquisition while eliminating gain recognition at the seller level, achieving a single level of tax with a stepped-up basis in target assets. (Treas. Reg. § 1.338(h)(10)-1(a))

Step 5A. Target Eligibility Categories

Three exclusive categories of eligible targets exist. Only targets falling within one of these categories may qualify for a § 338(h)(10) election. (Treas. Reg. § 1.338(h)(10)-1(b))

• Consolidated group target. The target is a member of a consolidated group (within the meaning of § 1.1502-1(h)) on the acquisition date and is NOT the common parent of that group. The target must be a domestic corporation. This is the most common factual pattern for § 338(h)(10) elections in corporate M&A. (Treas. Reg. § 1.338(h)(10)-1(b)(1))
  • Common parent exclusion explained. The common parent of a consolidated group is ineligible for § 338(h)(10) treatment because the statute requires the target to have been "a member of" the selling consolidated group, and the common parent is not a member of its own group in this structural sense. If the common parent is the target, § 338(g) or a § 336(e) election may be available instead.
  • Timing requirement. The target must be a member of the selling consolidated group immediately before the transaction. If the target was distributed out of the group prior to the stock sale, the consolidated target category is unavailable. Consider whether the affiliated target category or § 336(e) applies in that scenario.
• Affiliated target (non-consolidated). The target is a domestic corporation owned by a selling affiliate that is also a domestic corporation, where the selling affiliate owns stock in the target meeting the requirements of § 1504(a)(2) (at least 80% of vote and value), and the selling affiliate does NOT file a consolidated return with the target. (Treas. Reg. § 1.338(h)(10)-1(b)(3))
  • Structuring significance. The affiliated target category expands § 338(h)(10) eligibility beyond consolidated groups to include non-consolidated domestic parent-subsidiary structures. This category was added by the Technical and Miscellaneous Revenue Act of 1988 to fill a gap where affiliated groups did not file consolidated returns.
  • § 1504(a)(2) ownership test. The selling affiliate must hold stock possessing at least 80% of the total combined voting power of all classes of target stock entitled to vote and at least 80% of the total value of shares of all classes of stock (excluding nonvoting, nonparticipating, nonconvertible limited preferred stock). (§ 1504(a)(2))
  • TRAP. Foreign selling affiliates. A foreign corporation cannot qualify as a selling affiliate for purposes of § 338(h)(10). Both the selling affiliate and the target must be domestic corporations. If a foreign parent owns a domestic subsidiary, the affiliated target category is unavailable. Consider § 336(e) as an alternative in this structure. (Treas. Reg. § 1.338(h)(10)-1(b)(3))
• S corporation target. The target is an S corporation immediately before the acquisition date. All shareholders of the S corporation must consent to the election, including non-selling shareholders. (Treas. Reg. § 1.338(h)(10)-1(b)(4))
  • Full shareholder consent required. Every shareholder must consent, even those retaining their stock. A single dissenting shareholder precludes the election. Obtain written consent from ALL shareholders early in the transaction process. (Treas. Reg. § 1.338(h)(10)-1(c)(3))
  • S election status at acquisition date. The target must have a valid S election in effect immediately before the acquisition date. If the S election has terminated (for example, due to an ineligible shareholder acquiring stock prior to closing), the § 338(h)(10) election is unavailable because the target is not an S corporation "immediately before the acquisition date." (Treas. Reg. § 1.338(h)(10)-1(b)(4))

TRAP. Foreign targets are categorically ineligible. § 338(h)(10) applies by its terms only to domestic target corporations. A foreign target corporation cannot qualify under any of the three categories, regardless of whether the purchaser or seller is domestic. (§ 338(h)(10) by its terms.) (Treas. Reg. § 1.338(h)(10)-1(b).)

• Planning implication. If the target is foreign, evaluate § 338(g) (if a corporate purchaser exists) or a direct asset purchase as alternatives. § 336(e) is also unavailable for foreign targets because § 336(e) requires the seller to be a corporation and the regulations limit the election to domestic targets. (Treas. Reg. § 1.336-1(b)(2))
• Inbound planning note. A foreign seller owning a domestic target may qualify for § 338(h)(10) through the consolidated target or affiliated target category if the seller has a U.S. consolidated group or domestic corporate subsidiary structure.

Step 5B. Election Mechanics and Filing Requirements

Joint election requirement. The § 338(h)(10) election must be made jointly by (i) the purchasing corporation and (ii) the applicable seller (the selling consolidated group, the selling affiliate, or ALL S corporation shareholders). (Treas. Reg. § 1.338(h)(10)-1(c)(3))

• Who must join the election.
  • For consolidated targets, the purchasing corporation and the common parent of the selling consolidated group must jointly make the election. (Treas. Reg. § 1.338(h)(10)-1(c)(3)(i))
  • For affiliated targets, the purchasing corporation and the selling affiliate must jointly make the election. (Treas. Reg. § 1.338(h)(10)-1(c)(3)(ii))
  • For S corporation targets, the purchasing corporation and ALL shareholders of the S corporation (including non-selling shareholders) must jointly make the election. (Treas. Reg. § 1.338(h)(10)-1(c)(3)(iii))
    • CAUTION. Non-selling shareholder consent. Do not overlook shareholders who are not selling in the transaction. The regulations explicitly require consent from every shareholder, even those retaining their shares. Failure to obtain unanimous consent renders the election invalid. (Treas. Reg. § 1.338(h)(10)-1(c)(3))
• Form and timing. The election is made by filing Form 8023, "Elections Under § 338 for Corporations Making Qualified Stock Purchases," by the 15th day of the 9th month beginning after the month in which the acquisition date occurs. (Treas. Reg. § 1.338(h)(10)-1(c)(3))
  • Acquisition date defined. The acquisition date is the first day on which the purchasing corporation is considered to own stock in the target meeting the requirements of § 1504(a)(2) by reason of § 318(a) (at least 80% of vote and value). (§ 338(h)(2).) (Treas. Reg. § 1.338-1.)
  • Extension unavailable. The § 338(h)(10) election deadline is statutory and regulatory. There is no provision for late election relief under § 9100 for § 338(h)(10) elections. The Form 8023 must be timely filed. (Treas. Reg. § 1.338(h)(10)-1(c)(3))
• Irrevocability. The § 338(h)(10) election is irrevocable once made. A purchasing corporation that makes a § 338(h)(10) election is treated as having also made a § 338 election with respect to the qualified stock purchase. (Treas. Reg. § 1.338(h)(10)-1(c)(4))
  • Deemed § 338 election consequence. Because a valid § 338(h)(10) election automatically triggers a § 338 election, the purchasing corporation cannot separately elect out of § 338 treatment. The deemed asset sale mechanics of § 338(a) apply in full. (Treas. Reg. § 1.338(h)(10)-1(c)(4))
• Invalidity cascade. If a § 338(h)(10) election is invalid (for example, because a required party failed to consent or Form 8023 was not timely filed), the deemed § 338 election is also invalid. The transaction is then treated as a straight stock purchase with carryover basis in target assets under § 362. (Treas. Reg. § 1.338(h)(10)-1(c)(5))
  • Decision point. If the § 338(h)(10) election is VALID → the target is treated as having sold all its assets in a deemed sale and the seller recognizes no gain or loss on the stock sale. If INVALID → the transaction is treated as a stock purchase with no basis step-up in target assets (unless a separate valid § 338(g) election was made, which would require its own Form 8023 and timing). (Treas. Reg. § 1.338(h)(10)-1(c)(5))

Step 5C. Tax Consequences of a Valid § 338(h)(10) Election

Overview of the § 338(h)(10) deemed transaction. A valid § 338(h)(10) election produces a deemed asset sale by the target, nonrecognition of gain or loss at the seller level on the actual stock sale, and a deemed liquidation of the target into the seller, with the purchasing corporation acquiring a new corporation with stepped-up basis in the target assets. (Treas. Reg. § 1.338(h)(10)-1(d))

• Deemed sale of target assets. Old target is treated as transferring all of its assets to an unrelated person at the close of the acquisition date for the adjusted deemed sale price (ADSP). Old target recognizes all gain (subject to limitations) on this deemed asset sale. (Treas. Reg. § 1.338(h)(10)-1(d)(3)(i))
  • Loss limitation. Old target recognizes gain but may NOT recognize loss on the deemed sale beyond applicable limitations (such as the related party loss rules of § 267 and the built-in loss duplication rules). The deemed sale is treated as a fully taxable transaction. (Treas. Reg. § 1.338(h)(10)-1(d)(3)(i))
  • S corporation treatment. For an S corporation target, the S election continues through the close of the acquisition date. The deemed asset sale gain flows through to the S corporation shareholders under § 1366, and each shareholder adjusts basis under § 1367. The S corporation itself pays no entity-level tax on the deemed sale gain. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(i))
  • Consolidated target treatment. For a consolidated target, old target realizes the deemed sale tax consequences while still a member of the selling consolidated group. The selling group files a consolidated return that includes the acquisition date, and the tax on deemed sale gain is borne at the consolidated group level. (Treas. Reg. § 1.338(h)(10)-1(d)(7))
    • Group-level gain offset. The selling consolidated group may use its own tax attributes (including net operating losses) to offset the deemed sale gain recognized by old target. This is a significant advantage over § 338(g), where target-level tax cannot be offset by seller losses. (Treas. Reg. § 1.338(h)(10)-1(d)(7))
    • TRAP. No withdrawal of consolidated return permitted. Once a § 338(h)(10) election is made for a consolidated target, the selling consolidated group may NOT withdraw its consolidated return for the taxable year. The election locks the group into the consolidated filing. (Treas. Reg. § 1.338(h)(10)-1(d)(7)(ii))
• Nonrecognition at seller level. The selling consolidated group (or selling affiliate, or S corporation shareholders) recognizes NO gain or loss on the actual sale of target stock. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(iii))
  • This is the hallmark of § 338(h)(10). Unlike a § 338(g) election, which produces two levels of tax (target-level gain on deemed asset sale plus seller-level gain on actual stock sale), § 338(h)(10) eliminates the seller-level tax entirely. The seller is treated as having received the ADSP amount in a tax-free transaction. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(iii))
  • S corporation shareholder consequences. Each S corporation shareholder takes into account their pro rata share of the deemed asset sale tax consequences under § 1366 and adjusts stock basis under § 1367. The shareholders then recognize gain or loss on the deemed liquidation under § 331 and receive a basis in their retained shares of new target (now a C corporation) equal to fair market value. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(i))
  • Non-selling S corporation shareholders. Shareholders who retain their stock take into account their share of deemed sale gain under § 1366 and § 1367, recognize gain or loss on the deemed liquidation under § 331, and obtain a basis in their retained shares equal to fair market value determined by the ADSP formula. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(i))
• Deemed liquidation of old target. Old target is treated as liquidating immediately after the deemed asset sale. (Treas. Reg. § 1.338(h)(10)-1(d)(4))
  • Consolidated target liquidation. For a consolidated target, the deemed liquidation generally qualifies as a complete liquidation under § 332 (tax-free to the corporate distributee), provided the requirements of § 332 (80% ownership) are met at the time of liquidation, which they will be because the selling parent owned at least 80% immediately before the transaction. (Treas. Reg. § 1.338(h)(10)-1(d)(4)(i))
  • Affiliated target liquidation. The deemed liquidation of an affiliated target is similarly analyzed under § 332 if the selling affiliate meets the 80% ownership threshold. (Treas. Reg. § 1.338(h)(10)-1(d)(4)(ii))
  • S corporation target liquidation. The deemed liquidation of an S corporation target is analyzed under § 331 (taxable liquidation) because the shareholders are individuals, not corporations. Gain or loss recognized by shareholders on the deemed liquidation under § 331 takes into account the basis adjustments from the deemed asset sale flow-through items. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(i))
• Purchasing corporation consequences.
  • Automatic gain recognition election. P is automatically deemed to have made a gain recognition election under § 338(b)(3) for any nonrecently purchased stock. P recognizes gain (but not loss) on such stock as if it were sold on the acquisition date for fair market value. (Treas. Reg. § 1.338(h)(10)-1(d)(1))
    • Basis consequence. P's basis in nonrecently purchased stock is stepped up to fair market value as of the acquisition date, which becomes part of the AGUB calculation for new target's assets. (Treas. Reg. § 1.338(h)(10)-1(d)(1))
  • New target liability. New target (the purchasing corporation's target) remains liable for all federal income tax liabilities of old target, including the tax liability arising from the deemed asset sale. The purchasing corporation inherits this liability by operation of law through its ownership of new target. (Treas. Reg. § 1.338(h)(10)-1(d)(2))
    • CAUTION. Tax liability allocation negotiation. Because new target bears the economic cost of the deemed sale tax, the purchase agreement should explicitly address whether the purchase price is adjusted for this tax liability. In consolidated target transactions, the selling group files the return and pays the tax, but new target remains legally liable. (Treas. Reg. § 1.338(h)(10)-1(d)(2))
  • AGUB calculation. New target's basis in its assets is the adjusted grossed-up basis (AGUB), calculated as the sum of (i) the grossed-up basis of P's recently purchased stock, plus (ii) the basis of P's nonrecently purchased stock (after the deemed gain recognition election), plus (iii) liabilities of new target, adjusted for other relevant items. (§ 338(b).) (Treas. Reg. § 1.338-5.)
• Minority shareholder treatment. Minority shareholders who do not sell their target stock recognize no gain or loss and retain their existing basis and holding period in the stock. (Treas. Reg. § 1.338(h)(10)-1(d)(6))
  • Double tax risk for minority shareholders. Because old target recognizes the full amount of gain on the deemed asset sale, and the minority shareholders retain their carryover basis stock, a second level of tax will be imposed when the minority shareholders eventually sell their stock or upon liquidation. This is an unavoidable structural feature of § 338(h)(10). (Treas. Reg. § 1.338(h)(10)-1(d)(6))
  • Retained stock basis adjustment for selling group members. To the extent the selling consolidated group retains a minority interest in target stock, the retained stock receives a basis equal to the net fair market value of the portion of new target's assets that the selling member would have received if target had actually liquidated on the day after the acquisition date. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(ii))

Step 5D. Strategic Comparison with § 338(g)

§ 338(h)(10) generally dominates § 338(g) in subsidiary and S corporation acquisitions. The structural advantages explain its prevalence in transactional practice.

• Single level of tax for consolidated targets. Under § 338(h)(10), the consolidated target recognizes deemed asset sale gain at the group level, the selling group recognizes no gain on the stock sale, and the § 332 liquidation is tax-free. Only one level of tax is imposed, and the selling group's tax attributes can absorb the gain. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(iii).) (Treas. Reg. § 1.338(h)(10)-1(d)(4)(i).)
  • By contrast, § 338(g) produces two levels of tax. Target recognizes gain on the deemed asset sale, AND the selling group recognizes gain on the actual stock sale. No § 332 liquidation is available because the target is deemed to sell assets to itself (new target), not to its parent. (§ 338(a).) (Treas. Reg. § 1.338-1.)
  • EXAMPLE. Comparative tax burden. Assume target has asset basis of $50 and ADSP of $100, and seller's stock basis is $30. Under § 338(h)(10), target recognizes $50 of deemed asset sale gain taxed once at the group level, and seller recognizes $0 on the stock sale. Under § 338(g), target recognizes $50 of deemed asset gain, and seller recognizes $70 of stock sale gain ($100 proceeds minus $30 basis). § 338(h)(10) saves $70 of taxable gain at the seller level. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(iii))
• Flow-through treatment for S corporation targets. Under § 338(h)(10), S corporation deemed asset sale gain flows through to shareholders under § 1366, and no corporate-level tax is imposed (because S corporations generally are not subject to entity-level tax under § 1363). Under § 338(g), an S corporation target would be subject to corporate-level tax on the deemed asset sale because a § 338(g) election terminates the S election, converting the target to a C corporation for the deemed sale. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(i))
  • CAUTION. § 338(g) destroys S status. A § 338(g) election made for an S corporation target causes the S election to terminate because the purchasing corporation is an ineligible S corporation shareholder (a C corporation cannot be an S corporation shareholder unless it is a qualified subchapter S subsidiary, which requires 100% ownership). The target becomes a C corporation subject to double tax on the deemed sale. § 338(h)(10) avoids this result. (§ 1361(b)(1)(B).) (Treas. Reg. § 1.338(h)(10)-1(d)(3)(i).)
• Seller attribute utilization. Under § 338(h)(10), the selling consolidated group can apply its net operating losses and other tax attributes to offset the deemed asset sale gain. Under § 338(g), target-level tax cannot be sheltered by seller-level losses because the deemed sale occurs at the target level after the acquisition. (Treas. Reg. § 1.338(h)(10)-1(d)(7))
• When § 338(g) may still apply. § 338(h)(10) is unavailable where (i) the target is a foreign corporation, (ii) the target is the common parent of a consolidated group, (iii) the seller is an individual or partnership (not a corporation that can form a selling affiliate), or (iv) the transaction does not meet the § 1504(a)(2) ownership threshold. In these cases, § 338(g) or § 336(e) may be the only elective options for achieving a basis step-up. (Treas. Reg. § 1.338(h)(10)-1(b))
  • Cross-reference to Step 4. If the target is a foreign corporation, analyze § 338(g) under Step 4 (The § 338(g) Corporate-Level Election). If the seller is non-corporate, analyze § 336(e) under Step 6 (The § 336(e) Seller Election).

Step 6. The § 336(e) Seller Election

Under regulations prescribed by the Secretary, if— (1) a corporation owns stock in another corporation meeting the requirements of section 1504(a)(2), and (2) such corporation sells, exchanges, or distributes all of such stock, an election may be made to treat such sale, exchange, or distribution as a disposition of all of the assets of such other corporation, and no gain or loss shall be recognized on the sale, exchange, or distribution of such stock. (§ 336(e))

The § 336(e) election provides a seller-driven alternative to § 338(h)(10) with broader structural flexibility. It achieves a similar deemed asset sale result but without requiring a corporate purchaser, buyer consent, or a qualified stock purchase. (Treas. Reg. § 1.336-1(a))

Step 6A. Legislative Background and Purpose

Congress enacted § 336(e) as part of the Tax Reform Act of 1986 in response to the repeal of the General Utilities doctrine. (General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), holding that a corporation could distribute appreciated property to shareholders without recognizing corporate-level gain)

• General Utilities doctrine. Prior to the Tax Reform Act of 1986, the Supreme Court held in General Utilities that a corporation could distribute appreciated property to its shareholders in complete liquidation without recognizing gain at the corporate level. This allowed tax-free extraction of appreciated assets and formed the basis for numerous tax-advantaged corporate distributions. (General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935))
  • TRA 1986 repeal. Congress repealed the General Utilities doctrine as part of the broader effort to eliminate corporate-level nonrecognition on distributions of appreciated property. The repeal meant that liquidating corporations would recognize full gain on distributed property. (Tax Reform Act of 1986, Pub. L. No. 99-514, § 631(a))
  • Gap created by repeal. After the repeal, sellers seeking to dispose of subsidiary stock through distributions (rather than sales to third parties) had no mechanism to achieve a stepped-up basis in target assets without triggering full gain at both the corporate and shareholder levels. § 336(e) was enacted to fill this gap by providing an elective deemed asset sale mechanism for distributions and non-corporate purchasers. (Treas. Reg. § 1.336-1(a))
• Regulatory framework. Congress delegated authority to the Secretary to prescribe regulations under § 336(e). The Treasury Department issued comprehensive final regulations (T.D. 9619) in 2013, effective for transactions occurring on or after the date of publication. (Treas. Reg. §§ 1.336-1 through 1.336-5.) (T.D. 9619, 78 Fed. Reg. 17,943 (Mar. 25, 2013).)

Step 6B. Key Differences from § 338(h)(10)

§ 336(e) shares the same fundamental policy objective as § 338(h)(10) but achieves it through a structurally different mechanism. Five key differences distinguish the two elections.

• No corporate purchaser required. § 336(e) does not require the acquiring party to be a corporation. The purchaser may be an individual, a partnership, a limited liability company (taxed as a partnership or disregarded entity), a trust, a corporation, or a foreign person. This eliminates the § 338(h)(10) constraint that P must be a corporation. (Treas. Reg. § 1.336-1(b)(2))
  • Planning significance. If the buyer is a private equity fund organized as a partnership, an individual investor, or a foreign acquirer, § 338(h)(10) is unavailable (because a non-corporate purchaser cannot make a § 338 election) but § 336(e) may still apply. This is the most common reason § 336(e) is selected over § 338(h)(10). (Treas. Reg. § 1.336-1(b)(2))
  • Cross-reference to Step 5. If the purchaser is a corporation, both § 338(h)(10) and § 336(e) may be available. Evaluate both elections and select the one that produces the more favorable tax result based on the specific facts.
• Seller-driven election (no buyer consent). The § 336(e) election is made by the seller and the target corporation. The purchaser's consent is NOT required. This gives the seller control over the tax treatment of the transaction and removes a potential negotiation obstacle. (Treas. Reg. § 1.336-2(h))
  • Contrast with § 338(h)(10). A § 338(h)(10) election requires the purchasing corporation to join in the election, which means the buyer must agree. If the buyer objects (for example, because it does not want to inherit target tax liabilities), the § 338(h)(10) election cannot be made. § 336(e) bypasses this obstacle entirely. (Treas. Reg. § 1.338(h)(10)-1(c)(3))
• Aggregation of multiple dispositions to multiple buyers. § 336(e) permits aggregation of stock sales, exchanges, and distributions made to multiple unrelated buyers over a 12-month disposition period to satisfy the 80% threshold. § 338(h)(10) requires a single purchasing corporation (or affiliated group) to acquire the 80% threshold. (Treas. Reg. § 1.336-1(b)(6)(i))
  • EXAMPLE. Aggregation to reach 80%. Seller owns 100% of target. In Month 1, Seller sells 40% to Buyer A. In Month 3, Seller sells 40% to Buyer B. In Month 6, Seller distributes 20% to its shareholders. Under § 336(e), these dispositions can be aggregated to reach the 80% disposition threshold (40% plus 40%), and the election applies to the 20% distributed portion as well. Under § 338(h)(10), no single purchasing corporation acquired 80%, so the election would be unavailable. (Treas. Reg. § 1.336-1(b)(6)(i), Ex.)
• Availability for distributions, not just sales. § 336(e) explicitly covers sales, exchanges, AND distributions of target stock. A parent corporation that distributes subsidiary stock to its shareholders in a spin-off or split-off can make a § 336(e) election to treat the distribution as a deemed asset sale, achieving a basis step-up in target assets. § 338(h)(10) applies only to purchases and requires a purchasing corporation. (Treas. Reg. § 1.336-1(b)(5))
  • Distribution-specific advantage. This is the critical distinction for divisive transactions. If a corporation wants to distribute a subsidiary to its shareholders and achieve a stepped-up basis in the subsidiary's assets, § 336(e) is the only statutory election that applies. (Treas. Reg. § 1.336-1(b)(5))
• § 338 precedence in overlapping transactions. If a single transaction qualifies as both a qualified stock purchase under § 338 and a qualified stock disposition under § 336(e), § 338 takes precedence. The § 336(e) election is not available for transactions that independently satisfy the § 338 QSP requirements. (Treas. Reg. § 1.336-1(b)(6)(ii)(A))
  • Planning implication. If a corporate purchaser acquires 80% or more of target stock in a 12-month period, the transaction is a QSP, and the parties must choose between § 338(g) and § 338(h)(10) (if eligible). § 336(e) is off the table for that portion. If the transaction involves both a QSP and a distribution, the QSP portion falls under § 338, and only the non-QSP portion may qualify for § 336(e). (Treas. Reg. § 1.336-1(b)(6)(ii)(A))
  • CAUTION. Do not assume § 336(e) is available when a QSP exists. Always analyze whether the transaction independently satisfies the § 338(d)(3) QSP definition before assuming § 336(e) applies. If it does, § 338 is the exclusive statutory regime. (Treas. Reg. § 1.336-1(b)(6)(ii)(A))

Step 6C. Eligibility Requirements for a § 336(e) Election

Five threshold requirements must be satisfied for a § 336(e) election.

• Seller must be a corporation. The seller must be a domestic corporation that owns stock in the target meeting the § 1504(a)(2) requirements (at least 80% of vote and value). Unlike § 338(h)(10), the seller corporation need not be affiliated with any group. (Treas. Reg. § 1.336-1(b)(1))
• Target must be a domestic corporation. The target must be a domestic corporation. Foreign targets are ineligible for § 336(e), consistent with the limitation in § 338(h)(10). (Treas. Reg. § 1.336-1(b)(2))
• Qualified stock disposition (QSD) requirement. The seller must sell, exchange, or distribute stock of the target representing at least 80% of the vote and 80% of the value of the target's stock during a 12-month disposition period. (Treas. Reg. § 1.336-1(b)(4))
  • No "purchase" requirement. Unlike § 338, § 336(e) does not require the acquirer to have "purchased" the stock (within the meaning of § 338(h)(3)). The disposition can be by sale, exchange, distribution, or any combination thereof. (Treas. Reg. § 1.336-1(b)(5))
  • 12-month disposition period. The 12-month disposition period is analogous to the § 338 12-month acquisition period but is measured from the first disposition rather than the first purchase. (Treas. Reg. § 1.336-1(b)(4))
• No related party acquisitions. Stock acquired by a related person (determined under § 267 or § 707) during the 12-month disposition period is generally excluded from the QSD calculation unless the related person is a member of the seller's affiliated group. (Treas. Reg. § 1.336-1(b)(6)(iii))
• All target stock must be disposed of in aggregate. The seller must dispose of ALL of its target stock (100%) during the 12-month disposition period, whether through sale, exchange, or distribution. A § 336(e) election cannot be made if the seller retains any target stock after the disposition period closes. (Treas. Reg. § 1.336-1(b)(4))
  • Decision point. If seller disposes of 100% of target stock within 12 months → a QSD may exist. If seller retains ANY target stock → § 336(e) is unavailable. (Treas. Reg. § 1.336-1(b)(4))

Step 6D. Election Mechanics and Timing

The § 336(e) election is made through a binding written agreement, not a form filed with the IRS. The specific procedural requirements differ for S corporation targets and non-S corporation targets. (Treas. Reg. § 1.336-2(h))

• Non-S corporation targets. The seller and the target corporation must enter into a binding written agreement to make the § 336(e) election on or before the due date (including extensions) of the seller's or target's federal income tax return for the taxable year that includes the disposition date, whichever is earlier. An election statement must be attached to both the seller's and target's timely filed original (or amended) returns for that year. (Treas. Reg. § 1.336-2(h)(1))
  • Content of election statement. The statement must be entitled "§ 336(e) Election" and must include (i) the name and employer identification number of the seller, (ii) the name and employer identification number of the target, (iii) the date of the disposition, (iv) the percentage of target stock sold, exchanged, or distributed, and (v) a statement that all parties have entered into a binding written agreement to make the election. (Treas. Reg. § 1.336-2(h)(1))
  • Due date tie-breaker. When the seller and target have different tax years, the earlier due date controls. File the election by the earlier of the two due dates to preserve the election. (Treas. Reg. § 1.336-2(h)(1))
• S corporation targets. ALL shareholders of the S corporation (including non-disposing shareholders) and the S corporation itself must enter into a binding written agreement to make the election on or before the due date (including extensions) of the S corporation's federal income tax return for the taxable year that includes the disposition date. The election statement is attached to the S corporation's timely filed return. (Treas. Reg. § 1.336-2(h)(3))
  • Full shareholder consent required. As with § 338(h)(10), every S corporation shareholder must consent, even those who retain their stock. The consent must be in writing and must be part of the binding written agreement. (Treas. Reg. § 1.336-2(h)(3))
  • CAUTION. Non-disposing shareholder holdouts. A single dissenting shareholder who refuses to consent will preclude the § 336(e) election. Address this issue in the transaction negotiations by requiring all shareholders to commit to electing § 336(e) in the stock purchase agreement. (Treas. Reg. § 1.336-2(h)(3))
• Protective election permitted. If the seller is uncertain whether the transaction will qualify as a QSD (for example, because it is unclear whether 80% will be disposed of within the 12-month period), a protective § 336(e) election may be made. If the transaction ultimately fails to qualify as a QSD, the protective election has no effect. (Treas. Reg. § 1.336-2(h)(4))
  • When to use a protective election. Make a protective election whenever there is any material uncertainty about whether the 80% threshold will be met. The cost of filing is minimal, and the consequence of failing to elect is a carryover basis in target assets. (Treas. Reg. § 1.336-2(h)(4))
• Irrevocability. The § 336(e) election is irrevocable once made. The seller and target cannot rescind the election after the due date even if the election produces an unexpected tax result. (Treas. Reg. § 1.336-2(h)(5))

Step 6E. Deemed Transaction Consequences

A valid § 336(e) election produces three parallel tax events. The regulations construct a deemed transaction that mirrors the § 338(h)(10) result while accommodating the broader structural flexibility of § 336(e). (Treas. Reg. § 1.336-2(b)(1))

• Deemed asset disposition by old target. Old target is treated as selling all of its assets to an unrelated person at the close of the disposition date for the aggregate deemed asset disposition price (ADADP). Old target recognizes all gain (subject to applicable limitations) on this deemed sale. (Treas. Reg. § 1.336-2(b)(1)(i))
  • ADADP defined. The ADADP is the sum of (i) the grossed-up amount realized on the sale, exchange, or distribution of recently disposed stock, plus (ii) the target's liabilities on the disposition date, adjusted for other relevant items. The ADADP formula is functionally equivalent to the ADSP under § 338. (Treas. Reg. § 1.336-3)
  • Allocation among assets. The ADADP is allocated among target's assets under the residual method of § 1060 and Treas. Reg. §§ 1.338-6 and 1.338-7, applied by analogy. The purchasing corporation's basis in target assets is the aggregate adjusted grossed-up basis (AGUB). (Treas. Reg. § 1.336-3.) (Treas. Reg. § 1.336-4.)
• Deemed asset acquisition by new target. New target is treated as acquiring all of old target's assets from an unrelated person at the beginning of the day after the disposition date for the aggregate adjusted grossed-up basis (AGUB). The AGUB is allocated among target assets under the residual method. (Treas. Reg. § 1.336-2(b)(1)(ii))
  • S corporation new target. If the target was an S corporation, the S election terminates at the close of the disposition date. New target is a C corporation unless a new S election is made effective for the day after the disposition date. The purchasing party must file Form 2553 to elect S status for new target if pass-through treatment is desired. (Treas. Reg. § 1.336-2(b)(1)(ii).) (The Tax Adviser, "Making a § 336(e) Election for an S Corporation," May 2018.)
    • CAUTION. S status does not automatically continue. Unlike § 338(h)(10), where the S election continues through the acquisition date and terminates at the close of that date, a § 336(e) election does not automatically preserve S corporation status. The acquiring parties must proactively make a new S election if they want the target to be an S corporation after the transaction. (Treas. Reg. § 1.336-2(b)(1)(ii))
• Deemed liquidation of old target. Old target is treated as liquidating immediately after the deemed asset disposition. (Treas. Reg. § 1.336-2(b)(1)(iii))
  • Corporate seller liquidation. If the seller is a corporate shareholder, the deemed liquidation generally qualifies under § 332 (tax-free liquidation of a subsidiary into its 80% parent), provided the 80% ownership threshold is met immediately before the disposition. (Treas. Reg. § 1.336-2(b)(1)(iii)(A))
  • Non-corporate seller or S corporation target liquidation. If the seller is non-corporate or the target is an S corporation, the deemed liquidation is taxable under §§ 331 and 336, not under § 332. Shareholders recognize gain or loss equal to the difference between the fair market value of assets received and their stock basis (as adjusted by deemed sale flow-through items). (Treas. Reg. § 1.336-2(b)(1)(iii)(B))
• Disallowed loss rule for distributed stock. If target stock is distributed during the 12-month disposition period and old target has a net loss on the deemed asset disposition, a portion of that loss is disallowed. The disallowed amount equals the ratio of distributed stock to total disposed stock multiplied by the net loss. This prevents sellers from shifting tax losses to the target level through distributions. (Treas. Reg. § 1.336-2(b)(1)(i)(B)(2))
  • EXAMPLE. Disallowed loss on distribution. Seller owns 100% of target. Seller sells 60% of target stock to Buyer for $60 and distributes 40% to its shareholders. Target has a net loss of $20 on the deemed asset disposition. The disallowed loss is $8 ($20 multiplied by 40% divided by 100%). Seller can only utilize $12 of the net loss. (Treas. Reg. § 1.336-2(b)(1)(i)(B)(2), Ex.)
  • Purpose of the rule. Without this limitation, a seller could distribute stock to related shareholders (who would not recognize gain on receipt) and generate target-level losses through the deemed asset sale, effectively transferring loss attributes to the target for the purchaser's benefit. The disallowed loss rule prevents this abuse. (Treas. Reg. § 1.336-2(b)(1)(i)(B)(2))

Step 6F. Special S Corporation Liquidation Trap

TRAP. Liquidation of an S corporation target after a § 336(e) election can trigger unexpected gain when the acquirer is noncorporate.

• The structural problem. When a noncorporate acquirer (such as a partnership or individual) purchases an S corporation target and a § 336(e) election is made, the target becomes a C corporation after the disposition date. If the acquirer wants pass-through treatment, it must liquidate the target (typically into a limited liability company). (Treas. Reg. § 1.336-2(b)(1)(ii))
  • Taxable liquidation. This post-transaction liquidation is taxable under §§ 331 and 336, NOT tax-free under §§ 332 and 337. The target recognizes gain on distributing its assets to the LLC, and the shareholders (the acquirer) recognize gain on the liquidation. (§ 331(a).) (§ 336(a).)
  • Minimal gain due to stepped-up basis. Because the § 336(e) election gave the target assets a stepped-up basis equal to ADADP/AGUB, the additional gain recognized on the immediate post-transaction liquidation is generally minimal (limited to any appreciation between the disposition date and the liquidation date, plus transaction costs). (Treas. Reg. § 1.336-2(b)(1)(ii))
• The earnout trap. The liquidation may trigger unexpected gain if the purchase price includes contingent consideration (earnouts). The earnout payments increase the ADADP and AGUB over time as payments become fixed. If the target has been liquidated before all earnout payments are fixed, the basis step-up attributable to future earnout payments may be lost or reduced. (RSM US LLP, "§ 336(e) Elections and Contingent Consideration," Tax Alert, Feb. 2023)
  • Mechanism of the problem. Under the § 336(e) regulations, post-disposition earnout payments generally increase the target's basis in its assets (through an adjustment to AGUB). If the target no longer exists (having been liquidated), there is no mechanism to step up the basis of assets held by the LLC acquirer for those subsequent payments. The earnout payments become taxable to the LLC without a corresponding basis increase. (RSM US LLP, "§ 336(e) Elections and Contingent Consideration," Tax Alert, Feb. 2023)
  • Mitigation strategy. If the transaction includes contingent consideration, consider (i) delaying the liquidation of target until all earnout payments are fixed and paid, (ii) structuring the acquisition as a direct asset purchase instead, or (iii) using § 338(h)(10) instead of § 336(e) if a corporate purchaser is available (because § 338(h)(10) does not require a post-transaction liquidation to achieve pass-through treatment for a corporate purchaser that can make a § 338(h)(10) election and own the target as a qualified subchapter S subsidiary or C corporation). (RSM US LLP, "§ 336(e) Elections and Contingent Consideration," Tax Alert, Feb. 2023)
  • CAUTION. Model the earnout scenario before making § 336(e). If the transaction includes material earnout payments, run pro forma calculations under both § 336(e) and alternative structures (including direct asset purchase) to quantify the potential tax cost of the post-liquidation earnout trap. (RSM US LLP, "§ 336(e) Elections and Contingent Consideration," Tax Alert, Feb. 2023)
• Comparison with § 338(h)(10). Under § 338(h)(10), a corporate purchaser acquires the target as a C corporation subsidiary. No post-transaction liquidation is required. The stepped-up basis in target assets is preserved inside the corporate subsidiary. Earnout payments can be incorporated into the AGUB calculation through the ADSP formula without triggering a second taxable event. This is a significant advantage of § 338(h)(10) over § 336(e) when contingent consideration is present and a corporate purchaser is available. (Treas. Reg. § 1.338(h)(10)-1(d))

Step 6G. Coordinating § 336(e) with Other Transaction Structures

§ 336(e) interacts with other structural choices in ways that require careful sequencing.

• Direct asset purchase alternative. In many cases where § 336(e) is considered because the buyer is noncorporate, a direct asset purchase may be simpler and more tax-efficient. In a direct asset purchase, the buyer receives a cost basis in each asset without the complexity of deemed transactions, and the seller recognizes gain directly. § 336(e) is most valuable when a stock purchase form is required for non-tax reasons (such as contract assignment, licensing, or regulatory concerns) but a basis step-up is desired. (Treas. Reg. § 1.336-1(a))
• Integration with § 351 contributions. If the buyer is an individual who wants to operate the target business in a partnership, the individual could acquire the target stock, make a § 336(e) election, and then contribute the target's assets to a partnership under § 351. The § 351 contribution is generally tax-free, and the partnership takes a carryover basis in the assets (which is the stepped-up basis from the § 336(e) deemed sale). This avoids the taxable liquidation trap described in Step 6F. (§ 351(a).) (§ 723.)
  • Decision point. If the acquirer intends to operate in partnership form → consider contributing target stock to a partnership and making a § 336(e) election at the partnership level (if the partnership is the seller), or contribute assets after a § 336(e) election under § 351. Consult partnership tax counsel on the optimal sequencing. If the acquirer intends to operate in LLC form → the liquidation issue in Step 6F must be addressed. (§ 351(a))
• State tax considerations. Many states do not conform to federal § 336(e) treatment or require a separate state-level election. Analyze state tax consequences independently. A transaction that produces a stepped-up basis for federal purposes may produce a carryover basis for state purposes if the state does not recognize the § 336(e) election. (State conformity rules vary)
  • CAUTION. Check state conformity before making the election. Some states decouple from § 336(e) entirely. Others require a separate election form. The state tax cost of a deemed asset sale may exceed the federal benefit if the state does not permit the election or has different attribute utilization rules.

Step 7. ADSP - Aggregate Deemed Sale Price

ADSP is the amount for which old target is deemed to have sold all its assets in the deemed asset sale. It is the sum of the grossed-up amount realized on the sale to P of P's recently purchased target stock, the liabilities of old target, and other relevant items. (Treas. Reg. § 1.338-4(a))

• ADSP is the price at which old target is treated as selling all its assets in the deemed sale. ADSP is the sum of three components and is computed iteratively because the tax liability on the deemed sale gain affects and is affected by the ADSP amount. (Treas. Reg. § 1.338-4(b)(1)) See Step 9 for allocation of ADSP among target assets and Step 8 for the corresponding AGUB computation.
  • Grossed-up amount realized on recently purchased stock. This is the purchase price grossed up to reflect 100% of target value. (Treas. Reg. § 1.338-4(c))
    • Start with P's basis in recently purchased target stock at the beginning of the day after the acquisition date.
    • Multiply by the fraction (100% minus the percentage of target stock by value that is nonrecently purchased stock) divided by (the percentage of target stock by value that is recently purchased stock).
    • EXAMPLE. P purchases 80% of T stock for $800 and owns no other T stock. Grossed-up amount realized equals $800 multiplied by (100% minus 0%) divided by 80%, which equals $1,000. (Treas. Reg. § 1.338-4(c))
    • EXAMPLE. P purchases 80% of T stock for $800 and already owns 10% as nonrecently purchased stock with a $50 basis. Grossed-up amount realized equals $800 multiplied by (100% minus 10%) divided by 80%, which equals $900. (Treas. Reg. § 1.338-4(c))
  • Liabilities of old target included in ADSP. These are measured as of the beginning of the day after the acquisition date. (Treas. Reg. § 1.338-4(d))
    • Include the tax liability for the deemed sale gain recognized by old target.
    • This creates a circular computation because the tax liability on the deemed sale depends on the character and amount of gain, which depends on the ADSP allocation, which depends on the tax liability.
    • Under general principles of tax law, liabilities include those properly taken into account before the close of old target's first taxable year.
    • TRAP. The iterative computation means the practitioner must solve for ADSP simultaneously with the tax liability. Commercial tax software typically handles this computation but practitioners should verify the inputs. (Treas. Reg. § 1.338-4(b)(1))
  • Other relevant items. This component was eliminated in the 2001 final regulations. (Treas. Reg. § 1.338-4(b)(1)) Older materials or prior transaction documents may reference "other relevant items" but it no longer affects ADSP or AGUB computations. If reviewing historical transactions predating the 2001 regulations, verify which regulatory version applied.
• Timing of ADSP determination and redetermination. (Treas. Reg. § 1.338-4(b)(2))
  • ADSP is initially determined as of the beginning of the day after the acquisition date.
  • ADSP is redetermined at any time that increases or decreases are required under general principles of tax law.
  • Increases or decreases to ADSP taken into account before the close of old target's first taxable year are treated as if they occurred at the beginning of the day after the acquisition date.
  • Increases or decreases to ADSP after the close of the first taxable year trigger the reallocation rules of Treas. Reg. § 1.338-7.
  • CAUTION. Post-closing purchase price adjustments, earnouts, and contingent payments may require ADSP redetermination. If the redetermination occurs after the first taxable year, the reallocation mechanics under § 1.338-7 are significantly more complex than an in-year adjustment. (Treas. Reg. § 1.338-7)
• Relationship to AGUB and asset allocation. ADSP determines the amount of gain old target recognizes on the deemed sale. AGUB (see Step 8) determines new target's basis in the purchased assets. Both ADSP and AGUB are allocated using the same residual method across seven asset classes (see Step 9). If ADSP exceeds AGUB, old target recognizes gain on the deemed sale. If AGUB exceeds ADSP, new target receives a higher basis than the amount on which old target was taxed, creating a basis step-up without corresponding corporate-level tax.

Step 8. AGUB - Adjusted Grossed-Up Basis

For purposes of section 338, AGUB is the amount for which new target is deemed to have purchased all of its assets. AGUB is the sum of three components. (Treas. Reg. § 1.338-5(b)(1); § 338(b)(1))

• AGUB is new target's deemed purchase price for all target assets. It determines the total basis available for allocation among target's assets under the residual method. (Treas. Reg. § 1.338-5(b)(1)) See Step 9 for the allocation mechanics and Step 10 for the gain recognition election that affects Component 2 below.
  • Component 1. Grossed-up basis in recently purchased stock. (Treas. Reg. § 1.338-5(b)(1)(i)) (§ 338(b)(1)(A))
    • P's basis in recently purchased target stock at the beginning of the day after the acquisition date.
    • Multiplied by the fraction (100% minus the percentage of nonrecently purchased target stock by value) divided by (the percentage of recently purchased target stock by value).
    • This fraction is identical to the ADSP gross-up fraction. (Treas. Reg. § 1.338-5(c))
    • EXAMPLE. P buys 80% of T stock for $800 and owns no other T stock. Grossed-up basis equals $800 multiplied by (100% minus 0%) divided by 80%, which equals $1,000. (Treas. Reg. § 1.338-5(c))
  • Component 2. Basis in nonrecently purchased stock. (Treas. Reg. § 1.338-5(b)(1)(ii)) (§ 338(b)(1)(B))
    • P's basis in target stock owned on the acquisition date that was not acquired during the 12-month acquisition period.
    • If P makes a gain recognition election under § 338(b)(3), basis is stepped up to the "basis amount." See Step 10 for the full mechanics of this election. (Treas. Reg. § 1.338-5(d))
    • If P does not make a gain recognition election, nonrecently purchased stock carries over at its historical basis. (Treas. Reg. § 1.338-5(d))
    • In a § 338(h)(10) transaction, the gain recognition election is automatically deemed made for all nonrecently purchased stock. P has no choice and must recognize gain. (Treas. Reg. § 1.338(h)(10)-1(d)(1))
  • Component 3. Liabilities of new target. (Treas. Reg. § 1.338-5(b)(1)(iii)) (§ 338(b)(2))
    • The liabilities of new target as of the beginning of the day after the acquisition date.
    • Under general principles of tax law, liabilities include those properly taken into account before the close of new target's first taxable year.
    • This component is identical to the liability component of ADSP and creates the same circular computation considerations with respect to tax liabilities.
• Hypothetical purchase price for AGUB allocation when no gain recognition election is made. (Treas. Reg. § 1.338-6(c)(3))
  • If P holds nonrecently purchased stock and does not make a gain recognition election, the asset allocation uses a "hypothetical purchase price" concept.
  • Compute the hypothetical purchase price as if the gain recognition election had been made.
  • Allocate this hypothetical purchase price among target assets using the residual method described in Step 9.
  • Then ratchet each asset allocation down proportionally based on the ratio of actual AGUB (excluding cash) to hypothetical purchase price (excluding cash).
  • EXAMPLE. Actual AGUB equals $2,700. Hypothetical purchase price equals $3,000. Target has $100 of cash. The allocation fraction is ($2,700 minus $100) divided by ($3,000 minus $100), which equals 0.8966. Each non-cash asset receives 89.66% of the amount that would have been allocated under the hypothetical purchase price. (Treas. Reg. § 1.338-6(c)(3))
  • TRAP. The ratchet-down rule means that assets with the highest fair market value under the hypothetical allocation bear the greatest absolute reduction. This can materially alter the character of basis among asset classes compared to the hypothetical result.
• Timing of AGUB determination and redetermination. (Treas. Reg. § 1.338-5(b)(2))
  • AGUB is initially determined as of the beginning of the day after the acquisition date.
  • AGUB is redetermined at any time that increases or decreases are required under general principles of tax law.
  • Increases or decreases to AGUB taken into account before the close of new target's first taxable year are treated as if they occurred at the beginning of the day after the acquisition date.
  • Increases or decreases to AGUB after the close of the first taxable year trigger the reallocation rules of Treas. Reg. § 1.338-7.
  • CAUTION. Post-closing purchase price adjustments and earnouts that increase or decrease AGUB after the first taxable year require complex reallocation. The § 1.338-7 reallocation rules differ significantly from the initial allocation mechanics. (Treas. Reg. § 1.338-7)
• Cross-reference to ADSP. ADSP and AGUB are computed using parallel structures but may yield different amounts. ADSP uses grossed-up amount realized (based on purchase price paid) while AGUB uses grossed-up basis (which may differ if basis was stepped up under a gain recognition election). The difference between ADSP and AGUB creates the effective tax cost or benefit of the § 338 election. See Step 7 for ADSP computation.

Step 9. Asset Allocation Among Target Assets

The purchase price for an applicable asset acquisition is allocated among the assets using the residual method. (§ 1060(a); Treas. Reg. § 1.338-6(a))

• ADSP and AGUB are allocated among target's assets using the residual method across seven asset classes. The same allocation method applies to both ADSP and AGUB. The allocation proceeds sequentially from Class I through Class VII. (Treas. Reg. § 1.338-6(b)) (Form 8883 Instructions)
  • Class I. Cash and general deposit accounts. (Treas. Reg. § 1.338-6(b)(1))
    • Includes cash and general deposit accounts (including savings and checking accounts).
    • Class I assets are subtracted first from the total ADSP or AGUB before allocating to subsequent classes.
    • The amount allocated to Class I assets equals the face amount of the cash and deposit accounts.
  • Class II. Actively traded personal property. (Treas. Reg. § 1.338-6(b)(2))
    • Includes certificates of deposit, foreign currency, and publicly traded stock and securities.
    • The remaining amount after Class I is allocated to Class II assets in proportion to their fair market values, but no asset may receive an allocation exceeding its fair market value. (Treas. Reg. § 1.338-6(c)(1))
    • If the remaining amount exceeds the aggregate fair market value of all Class II assets, each Class II asset receives a full fair market value allocation and the excess carries forward to Class III.
  • Class III. Accounts receivable, mortgages, and credit card receivables. (Treas. Reg. § 1.338-6(b)(3))
    • Includes accounts receivable, mortgages, and credit card receivables.
    • Allocation proceeds in the same manner as Class II. The remaining amount after Class II is allocated in proportion to fair market values, up to the fair market value of each asset. (Treas. Reg. § 1.338-6(c)(1))
  • Class IV. Inventory or stock in trade. (Treas. Reg. § 1.338-6(b)(4))
    • Includes inventory or other property of a kind that would properly be included in inventory if on hand at the close of the taxable year.
    • Allocation proceeds in the same proportion-to-fair-market-value manner, capped at each asset's fair market value. (Treas. Reg. § 1.338-6(c)(1))
  • Class V. All assets not in other classes. (Treas. Reg. § 1.338-6(b)(5))
    • Includes furniture, fixtures, buildings, equipment, land, vehicles, and any tangible or intangible asset not included in Classes I through IV or Classes VI and VII.
    • Allocation proceeds in the same proportion-to-fair-market-value manner, capped at each asset's fair market value. (Treas. Reg. § 1.338-6(c)(1))
    • CAUTION. Assets that appear intangible but do not qualify as § 197 intangibles fall into Class V. This includes assets with ascertainable useful lives that are separately identifiable (for example, certain software not covered by § 197(d)(1)(C)). Class V assets are generally depreciated or amortized under their applicable Code sections rather than under § 197.
  • Class VI. § 197 intangibles except goodwill and going concern value. (Treas. Reg. § 1.338-6(b)(6))
    • Includes covenants not to compete, franchises, trademarks, trade names, patents, copyrights, customer lists, workforce in place, and other § 197 intangibles other than goodwill and going concern value.
    • Allocation proceeds in the same proportion-to-fair-market-value manner, capped at each asset's fair market value. (Treas. Reg. § 1.338-6(c)(1))
    • Class VI intangibles are amortized over 15 years under § 197(a). (§ 197(a)) (Treas. Reg. § 1.197-2(f)(1)(i))
    • TRAP. Under § 197(f)(1)(A), no loss is recognized on the disposition of a § 197 intangible if the taxpayer retains other § 197 intangibles acquired in the same transaction or series of related transactions. Instead, the basis of the retained § 197 intangibles is increased by the unrecognized loss.
    • TRAP. Under § 197(f)(1)(B), a covenant not to compete is not treated as disposed of before the disposition of the entire business interest or substantially all of the assets used in the trade or business that was acquired. This prevents early recognition of loss on a covenant not to compete.
  • Class VII. Goodwill and going concern value. (Treas. Reg. § 1.338-6(b)(7))
    • Any amount remaining after allocation to Classes I through VI is allocated to Class VII goodwill and going concern value.
    • Class VII goodwill and going concern value are amortized over 15 years under § 197(a). (§ 197(a)) (Treas. Reg. § 1.197-2(f)(1)(i))
    • TRAP. If the ADSP or AGUB exceeds the aggregate fair market value of all identifiable assets, the entire excess flows to Class VII. Conversely, if the aggregate fair market value of identifiable assets exceeds the ADSP or AGUB, no amount may be allocated to Class VII and the capped allocations in prior classes will reflect bargain purchase treatment.
• The fair market value ceiling on allocations. (Treas. Reg. § 1.338-6(c)(1))
  • No amount may be allocated to a specific asset (other than Class VII goodwill and going concern value) in excess of its fair market value.
  • This ceiling applies independently within each asset class.
  • If the remaining unallocated amount exceeds the aggregate fair market value of all assets in a given class, each asset in that class receives a full fair market value allocation and the excess proceeds to the next class.
  • TRAP. A bargain purchase (where ADSP or AGUB is less than the aggregate fair market value of all assets) means some assets will receive allocations below their fair market values. The residual method allocates the shortfall proportionally within each class based on relative fair market values.
• Contingent consideration and post-closing adjustments.
  • If the purchase price is later increased or decreased (including through earnouts, working capital adjustments, or indemnification payments), AGUB is redetermined and reallocated among assets. (Treas. Reg. § 1.338-7)
  • For earnouts and contingent payments that resolve after the acquisition date, the additional basis is allocated under the residual method and is amortized over the remaining amortization period of the asset to which it is allocated. (Treas. Reg. § 1.197-2(f)(2)(i))
  • TRAP. Earnouts that increase ADSP or AGUB after the close of new target's first taxable year trigger the reallocation rules of Treas. Reg. § 1.338-7 rather than a simple in-year adjustment. The reallocation may require reopening prior year depreciation and amortization schedules.
• Reporting. The asset allocation is reported on Form 8883 (Asset Allocation Statement Under § 338). Both the purchasing corporation and target (or old target's consolidated group) must file Form 8883. (Form 8883 Instructions)

Step 10. Gain Recognition Election for Nonrecently Purchased Stock

A purchasing corporation may elect to recognize gain with respect to nonrecently purchased stock. The amount of gain is the excess of the basis amount over the purchasing corporation's basis in the nonrecently purchased stock. (Treas. Reg. § 1.338-5(d); § 338(b)(3))

• Purpose of the gain recognition election. The election steps up the basis of nonrecently purchased stock so that AGUB reflects a full 100% valuation of the target. Without the election, nonrecently purchased stock retains its historical basis, reducing AGUB and the basis available for allocation to target assets. (§ 338(b)(3)) (Treas. Reg. § 1.338-5(d)) See Step 8 for how this basis feeds into the AGUB computation.
  • When the election applies. The election is available when P owns target stock before the 12-month acquisition period (nonrecently purchased stock). If P acquired 100% of target stock during the 12-month acquisition period, no nonrecently purchased stock exists and this election is irrelevant.
  • How the gain recognition election works. (Treas. Reg. § 1.338-5(d))
    • P elects to recognize gain as if each share of nonrecently purchased stock were sold for its "basis amount."
    • The basis amount equals the grossed-up basis of recently purchased stock multiplied by the fraction (the percentage of nonrecently purchased stock) divided by (100% minus the percentage of nonrecently purchased stock).
    • EXAMPLE. P purchases 80% of T stock for $800. P already owned 10% as nonrecently purchased stock with a $50 basis. Grossed-up basis equals $800 divided by 0.80, which equals $1,000. Basis amount for the nonrecently purchased stock equals $1,000 multiplied by (10% divided by 90%), which equals $111.11. P recognizes gain of $111.11 minus $50, which equals $61.11. The new basis in the nonrecently purchased stock for AGUB purposes is $111.11. (Treas. Reg. § 1.338-5(d))
    • AGUB includes $111.11 (rather than $50) for that nonrecently purchased stock. See Step 8, Component 2.
  • Deemed gain recognition in § 338(h)(10) transactions. (Treas. Reg. § 1.338(h)(10)-1(d)(1))
    • In a § 338(h)(10) election, gain recognition is automatically deemed made for all nonrecently purchased stock.
    • P has no choice. P must recognize gain on nonrecently purchased stock.
    • This deemed election ensures that the full step-up in asset basis occurs under § 338(h)(10).
    • Decision point. Is the transaction a § 338(h)(10) election? If YES → gain recognition is automatic and P must recognize gain on all nonrecently purchased stock. If NO → P must affirmatively elect gain recognition on Form 8023 or the nonrecently purchased stock retains its historical basis in the AGUB computation.
• TRAP. The election recognizes gain but not loss. If the basis amount is less than the historical basis of the nonrecently purchased stock, no loss is recognized. P cannot use a gain recognition election to create a loss. (Treas. Reg. § 1.338-5(d))
  • EXAMPLE. P purchases 80% of T stock for $800. P already owned 10% as nonrecently purchased stock with a $200 basis. Grossed-up basis equals $1,000. Basis amount equals $1,000 multiplied by (10% divided by 90%), which equals $111.11. Because the basis amount ($111.11) is less than historical basis ($200), P recognizes no gain and no loss. The nonrecently purchased stock basis for AGUB purposes is $111.11. P effectively forfeits $88.89 of built-in loss in the stock basis. (Treas. Reg. § 1.338-5(d))
• Mechanics of making the election.
  • The gain recognition election is made on Form 8023, Line 8.
  • The election must include a schedule containing the target name and the name, address, and EIN of each member of the purchasing corporation group holding nonrecently purchased stock.
  • The schedule must include a declaration that each such member agrees to report the gain recognized under the election.
  • The declaration must be signed under penalties of perjury by a person authorized to sign for each member holding nonrecently purchased stock. (Form 8023 Instructions)
  • The election applies to all target affiliates that have the same acquisition date.
• Interaction with the hypothetical purchase price rule. If P does not make a gain recognition election, the asset allocation uses the hypothetical purchase price method described in Step 8. This ratchet-down approach produces a different allocation result than if the election had been made. When evaluating whether to make the election, compare (A) the tax cost of recognizing gain on nonrecently purchased stock against (B) the present value of additional depreciation and amortization deductions from the higher asset basis that would result from the election.
• CAUTION. The gain recognition election is irrevocable. Once made on a timely filed Form 8023, the election cannot be revoked without IRS consent. If P is uncertain about the tax characterization or valuation of nonrecently purchased stock, the election should be analyzed carefully before filing. Consider the alternative of forgoing the election and accepting the lower AGUB with the ratchet-down allocation method.

Step 11. Target Affiliates and Tiered Targets

Step 11A. Definition of Target Affiliate

"The term 'target affiliate' means any corporation which is affiliated with target." (§ 338(h)(6); Treas. Reg. § 1.338-2(b)(18))

• Target affiliate status requires 80% vote and value affiliation. A corporation qualifies as a target affiliate only if target directly or indirectly owns stock satisfying the § 1504(a)(2) requirements (at least 80% of total voting power and 80% of total value, excluding certain § 1504(a)(4) preferred stock) at any time during the consistency period. (§ 338(h)(6), Treas. Reg. § 1.338-2(b)(18))
• A target affiliate acquired in a qualified stock purchase is itself a target. If purchasing corporation acquires at least 80% of a target affiliate in a QSP, that subsidiary simultaneously constitutes both a target affiliate (because it is affiliated with the original target) and a target in its own right (because it was acquired in a QSP). (Treas. Reg. § 1.338-2(b)(18))
  • This dual status means a separate § 338 election decision must be made for each target affiliate acquired in a QSP.
  • If YES, target affiliate is acquired in a QSP → analyze it as both a target affiliate and a separate target under Steps 3 through 10.
  • If NO, target affiliate is not acquired in a QSP → it remains relevant solely for target affiliate rules governing the parent target's deemed sale.
• § 338(h)(6)(B)(i) corporations retain target affiliate status. Certain insurance companies described in § 338(h)(6)(B)(i) are treated as target affiliates for all § 338 purposes notwithstanding their ineligibility for consolidated return treatment. (§ 338(h)(6)(B)(i))
  • Do not exclude these entities from the target affiliate analysis.

Step 11B. Deemed Sale of Target Affiliate Stock by Target

• Deemed sale of subsidiary stock is included in target's deemed sale. If target owns stock of a target affiliate, target's deemed sale of assets under § 338(a)(1) or § 338(h)(10) includes a deemed sale of that subsidiary stock. (Treas. Reg. § 1.338-4(h))
  • The deemed sale of subsidiary stock is treated as a separate transaction from the subsidiary's own deemed asset sale (if a § 338 election is made for the subsidiary).
• Gain or loss recognition depends on whether § 338 election is made for the subsidiary target affiliate.
  • If YES, § 338 election is made for subsidiary target affiliate → gain or loss on the deemed sale of subsidiary stock by the parent target is NOT recognized. The subsidiary's deemed asset sale and the parent’s deemed stock sale are integrated so that gain or loss is effectively eliminated. (Treas. Reg. § 1.338-4(h))
  • If NO, § 338 election is NOT made for subsidiary target affiliate → target recognizes gain or loss on the deemed sale of the subsidiary stock as if it sold the shares in an actual taxable transaction. The subsidiary retains its historical tax attributes and carryover basis in its assets.
• TRAP. Parent recognition of subsidiary stock sale gain in § 338(h)(10) transactions. In a § 338(h)(10) transaction where a parent-level election is made but no election is made for a subsidiary target affiliate, the selling consolidated group (or S corporation shareholders) must recognize gain on the deemed sale of the subsidiary stock. The deemed asset sale treatment at the parent level does not eliminate this gain. (Treas. Reg. § 1.338-4(h), Treas. Reg. § 1.338(h)(10)-1(c), Example 1)
  • Cross-reference Step 14 for anti-churning implications if the subsidiary stock sale results in stepped-up basis in intangibles.

Step 11C. Parent-Subsidiary Ordering Rules

• Parent's deemed asset sale precedes subsidiary's deemed asset sale. In parent-subsidiary chains where § 338(h)(10) elections are made for both parent and subsidiary, the parent's deemed asset sale under § 338(h)(10)(A) occurs before the subsidiary's deemed asset sale. (Treas. Reg. § 1.338(h)(10)-1(d)(3)(ii))
  • This ordering determines the sequence in which ADSP and AGUB are computed and ensures that the subsidiary's deemed liquidation basis reflects the parent's deemed sale consequences.
• Subsidiary's deemed liquidation precedes parent's deemed liquidation. The subsidiary's deemed liquidation distribution to the parent under § 338(h)(10)(B) occurs before the parent's deemed liquidation distribution to its shareholders. (Treas. Reg. § 1.338(h)(10)-1(d)(3)(ii))
  • This ordering ensures that the subsidiary's tax attributes (including earnings and profits) flow up through the chain before the parent's liquidation is complete.
  • If subsidiary has net operating losses or other tax attributes, determine whether they offset gain at the parent level in the proper sequence under this ordering rule.

Step 11D. Consistency Rules for Related Targets

• Election flexibility is available for the top-tier target only. If a § 338 election is made for a parent target, the purchasing corporation may independently choose whether to make a § 338 election for any subsidiary target affiliate acquired in a QSP. (Treas. Reg. § 1.338-8(a)(1))
  • Each subsidiary target affiliate is analyzed independently for § 338 eligibility under Steps 3 through 7.
• Cherry-picking prohibition for lower-tier subsidiaries. If the purchasing corporation chooses NOT to make a § 338 election for a particular subsidiary target affiliate, then NO § 338 election may be made for any lower-tier subsidiary in the chain below that entity. (§ 338(h)(3)(B), Treas. Reg. § 1.338-8(a)(1))
  • This prevents selective stepping-up of basis in favorable subsidiaries while preserving carryover basis in less favorable lower-tier entities.
  • EXAMPLE. P acquires T in a QSP. T owns S1, and S1 owns S2. If P makes a § 338 election for T but not for S1, P cannot make a § 338 election for S2 even if S2 is acquired in a QSP.
• Decision tree for tiered targets. For each subsidiary in the ownership chain, determine the following in order from top to bottom.
  • Is the subsidiary acquired in a QSP? If NO → no § 338 election is possible for this subsidiary or any entity below it.
  • If YES, does the purchasing corporation want stepped-up basis? If YES → make § 338 election and continue analysis for next lower tier.
  • If NO, § 338 election is foregone → no § 338 election may be made for any lower-tier subsidiary regardless of QSP status.

Step 12. Consistency Rules Under §§ 338(e) and 338(f)

Step 12A. Purpose and Scope of Consistency Rules

"If a purchasing corporation acquires an asset from a target corporation during the target consistency period and the target corporation is a subsidiary in a consolidated group at the time of the acquisition, the purchasing corporation's basis in the asset is the same as the basis of the asset in the hands of the target corporation unless a section 338 election is made for the target corporation." (Treas. Reg. § 1.338-8(a)(2))

• Consistency rules prevent selective basis step-up through pre-acquisition asset sales. The rules ensure that purchasing corporation cannot obtain stepped-up basis in some target assets (through a direct acquisition) while preserving carryover basis in the target stock (by forgoing a § 338 election). (Treas. Reg. § 1.338-8(a)(1))
  • The mechanism operates by denying stepped-up basis in direct asset acquisitions from target unless a § 338 election is made for target, forcing the purchasing corporation to internalize the tax cost of the asset sale through carryover basis.
• General carryover basis rule applies to direct asset acquisitions from consolidated subsidiaries. If P acquires an asset directly from target during the target consistency period, and target is a subsidiary member of a consolidated group at the time of the acquisition, P takes a carryover basis in the asset equal to target's basis immediately before the sale unless a § 338 election is made for target. (Treas. Reg. § 1.338-8(a)(2))
  • The gain from the asset sale is reflected in the basis of target stock under § 1.1502-32 investment adjustment provisions, so the consolidated group already bears the tax burden of the asset sale.
• Application limited to consolidated group subsidiaries. The carryover basis rule in Treas. Reg. § 1.338-8(a)(2) applies only if target is a subsidiary in a consolidated group at the time of the asset sale. If target is a freestanding C corporation or an S corporation, the consistency rules of §§ 338(e) and 338(f) may not apply through this specific regulatory mechanism.

Step 12B. Target Consistency Period

• The consistency period generally spans target's taxable year including the acquisition date. The target consistency period begins on the first day of target's taxable year that includes the acquisition date and ends on the acquisition date itself. (Treas. Reg. § 1.338-8(e))
  • Asset sales by target to P during this window trigger the carryover basis rule if the other conditions are satisfied.
• Anti-avoidance extension for tax avoidance transactions. The consistency period may be extended under anti-avoidance rules if asset sales are structured with a principal purpose of avoiding the consistency rules. (Treas. Reg. § 1.338-8(e))
  • Examine whether any pre-acquisition asset transfers were made in contemplation of the stock acquisition with a view toward obtaining selective basis treatment.

Step 12C. Indirect Acquisitions and Arrangements

• Consistency rules extend to indirect acquisitions where an arrangement exists. If purchasing corporation acquires an asset indirectly from target through an arrangement (such as a distribution to a selling shareholder followed by sale to P), the carryover basis rule applies as if the acquisition were direct. (Treas. Reg. § 1.338-8(f))
  • An arrangement exists if the transactions are agreed upon in advance or are otherwise interdependent steps in a unified plan.
• Dividends qualifying for 100% DRD under § 243(a)(3) are subject to special treatment. Certain dividends from target to its parent that qualify for the 100% dividends-received deduction under § 243(a)(3) may be treated as subject to the consistency rules in specific circumstances described in Treas. Reg. § 1.338-8(g). (Treas. Reg. § 1.338-8(g))
  • This prevents a consolidated group from distributing appreciated assets to the common parent as a dividend (without gain recognition under § 311(a) in consolidated returns) and then having P acquire the assets with stepped-up basis from the parent.

Step 12D. Foreign Target Affiliates That Are CFCs

• Income or gain of a CFC target affiliate from asset disposition is generally not reflected in target stock basis. For purposes of the consistency rules, income or gain of a controlled foreign corporation target affiliate from an asset disposition does not result in a § 1.1502-32 investment adjustment to the basis of target stock unless the income or gain triggers an inclusion to the U.S. shareholder under § 951(a)(1)(A), § 951(a)(1)(C), § 1291, or § 1293. (Treas. Reg. § 1.338-8(h))
  • This exception prevents foreign-to-foreign asset transfers from inappropriately triggering the consistency rules when no U.S. tax is imposed on the CFC's gain.
  • Cross-reference Step 13 for additional analysis of CFC issues in § 338 transactions.
• Practical effect. If target's CFC subsidiary sells assets but the gain is not currently includible in the U.S. parent's income under Subpart F or other relevant provisions, the consistency period asset sale does not create a carryover basis obligation for P if P later acquires those assets.

Step 13. Foreign Targets and International Considerations

Step 13A. § 338(g) Elections for Foreign Targets

• Foreign targets are eligible for § 338(g) elections. A § 338(g) election may be made with respect to a qualified stock purchase of a foreign corporation. The acquisition of foreign target stock in a QSP is treated the same as a domestic target acquisition for purposes of § 338(g). (AM 2007-006, Feb. 23, 2007, concluding that foreign targets are eligible for § 338(g) treatment)
  • § 338(h)(10) is NOT available for foreign targets because the statute limits § 338(h)(10) elections to domestic corporations that are (i) subsidiaries in a consolidated group, (ii) targets in a qualified stock purchase where an affiliate of the purchasing corporation makes the QSP, or (iii) S corporations. (§ 338(h)(10)(A), Treas. Reg. § 1.338(h)(10)-1(b)(1))
  • If the target is foreign and the transaction otherwise resembles a § 338(h)(10) transaction, the only available election is § 338(g).
• U.S. tax effects of a § 338(g) election for a foreign target. A § 338(g) election with respect to a foreign target is solely for U.S. federal income tax purposes and typically does not generate foreign income tax liability.
  • Gain on the deemed sale of foreign target assets (other than U.S. real property interests under § 897) is foreign-source under § 865 and generally is not subject to U.S. federal income tax if the foreign corporation has no U.S. trade or business.
  • This can create what practitioners describe as a "free step-up" in U.S. tax basis without a corresponding foreign tax cost.
  • The stepped-up U.S. tax basis in foreign target assets may generate future depreciation or amortization deductions for U.S. tax purposes.
• § 338(h)(16) limits foreign tax credit consequences. § 338(h)(16) provides that § 338 does NOT apply for purposes of determining the source or character of any item for purposes of §§ 901 through 908 (the foreign tax credit provisions). (§ 338(h)(16))
  • This prevents artificial foreign tax credit planning through the deemed asset sale mechanism.
  • Treas. Reg. § 1.338-9 provides specific exceptions and operational rules for the § 338(h)(16) limitation.
  • Cross-reference Step 13D for § 901(m) basis mismatch issues that may arise from U.S.-only step-ups.

Step 13B. CFC Pitfall in Creeping Acquisitions

• CFC status before the acquisition date may trigger Subpart F or GILTI inclusion on deemed sale gain. If the purchasing corporation is already a U.S. shareholder of the foreign target before the acquisition date and target is a controlled foreign corporation, the deemed sale gain triggered by a § 338(g) election may be includible in the purchasing corporation's income as Subpart F income under § 951(a)(1)(A) or as global intangible low-taxed income under § 951A. (The Tax Adviser, May 2024, KPMG Hot Topics in Cross-Border M&A 2024)
  • This result is particularly problematic in "creeping acquisitions" where the purchaser first acquires a non-controlling interest that triggers CFC status and then later crosses the 80% threshold for a QSP.
• Mechanism of the CFC trap in creeping acquisitions.
  • If USCo acquires 10% or more of Foreign Target's stock, USCo becomes a U.S. shareholder.
  • If USCo, together with related persons, constructively or actually owns more than 50% of Foreign Target's stock (by vote or value), Foreign Target becomes a CFC.
  • If USCo later acquires additional shares to cross the 80% QSP threshold, the acquisition date for § 338 purposes is the date the 80% threshold is crossed.
  • A § 338(g) election on that acquisition date triggers a deemed sale of all Foreign Target's assets. The deemed sale gain may constitute Subpart F income or increase tested income for GILTI purposes.
  • Because the § 338(g) election is solely for U.S. tax purposes, the deemed sale may not generate foreign income tax, leaving the U.S. shareholder with inclusion but no foreign tax credits.
• EXAMPLE. USCo acquires 40% of Foreign Target on January 1. This acquisition makes USCo a U.S. shareholder in a CFC (assuming related ownership crosses the 50% CFC threshold). USCo then acquires the remaining 60% of Foreign Target on August 1. The acquisition date for § 338 purposes is August 1. A § 338(g) election triggers deemed sale gain on all of Foreign Target's assets. Forty percent of the deemed sale gain (representing USCo's pre-existing ownership) is included in USCo's income as Subpart F or GILTI. Because the deemed sale is not recognized for foreign tax purposes, no foreign tax may be available for foreign tax credit purposes.
• Mitigation strategies. Consider whether the purchasing corporation can structure the acquisition to avoid CFC status before the QSP (e.g., through non-U.S. blocker entities or by ensuring no single U.S. shareholder crosses the 10% threshold before the QSP).
  • If the CFC trap cannot be avoided, model the U.S. tax cost of the deemed sale inclusion against the benefit of the stepped-up basis to determine whether the § 338(g) election is still advantageous.
  • Cross-reference Step 16 for multi-step acquisition structuring issues.

Step 13C. § 336(e) Availability for Foreign Targets

• § 336(e) is not available if either seller or target is a foreign corporation. § 336(e) and the accompanying regulations explicitly limit the election to domestic corporations. A § 336(e) election may not be made if either the seller or the target is a foreign corporation. (§ 336(e), Treas. Reg. § 1.336-1(b))
  • If the target is foreign, the only stock-sale-to-asset-sale conversion election available is § 338(g).
  • If the seller is foreign but the target is domestic, § 336(e) is still unavailable. The transaction must qualify for § 338(h)(10) (if all other requirements are met) or proceed as a stock sale without conversion.

Step 13D. § 901(m) Basis Mismatch Considerations

• Step-up in U.S. tax basis without foreign tax basis step-up may create § 901(m) disqualified payments. When a § 338(g) election creates stepped-up basis in U.S. tax accounts but foreign tax basis remains unchanged, subsequent deductions or cost recoveries attributable to the U.S. step-up may generate disqualified foreign income taxes under § 901(m).
  • § 901(m) denies foreign tax credits for foreign taxes attributable to foreign income that is offset by deductions or adjustments arising from a basis difference between U.S. and foreign tax accounts.
  • Model the multi-year impact of any § 901(m) disqualified payments against the present value of the stepped-up basis deductions.
  • If the foreign target operates in a high-tax jurisdiction, the § 901(m) limitation may significantly reduce the net benefit of the § 338(g) election.

Step 14. Anti-Churning Rules Under § 197(f)(9)

Step 14A. Purpose and General Rule

"No depreciation or amortization deduction shall be allowed under this chapter with respect to any amortizable section 197 intangible resulting from a transaction (directly or indirectly) involving a related person if the intangible was held or used at any time on or after July 25, 1991, and on or before August 10, 1993, by the taxpayer or a related person." (§ 197(f)(9)(A))

• Anti-churning rules prevent creation of amortizable basis in previously nonamortizable intangibles through related-party transactions. Congress enacted § 197(f)(9) to stop taxpayers from restructuring ownership of self-created intangibles (which are not amortizable under § 197) into purchased intangibles (which are amortizable over 15 years) through transactions with related persons. (§ 197(f)(9), Treas. Reg. § 1.197-2(h)(1))
  • The anti-churning rules deny amortization deductions for § 197 intangibles that were held or used by the taxpayer (or a related person) during the "transition period" (July 25, 1991 through August 10, 1993) and were acquired from a related person after August 10, 1993.
• Related person for anti-churning purposes uses a 20% common ownership test. For purposes of § 197(f)(9), the related person determination uses a 20% common ownership threshold instead of the normal 50% threshold under § 267(b) or § 707(b)(1). (Treas. Reg. § 1.197-2(h)(6)(i)(A))
  • Two persons are related for anti-churning purposes if the relationship would be described in § 267(b) or § 707(b)(1) by substituting "20%" for "50%" each place it appears.
  • This lower threshold captures a broader range of transactions than the standard related-party rules.

Step 14B. Application to § 338 Deemed Acquisitions

• New target is not treated as the person that held assets during old target's ownership period. In a § 338 transaction (including both § 338(g) and § 338(h)(10)), new target is NOT considered the person that held or used assets during any period in which the assets were held by old target. (Treas. Reg. § 1.197-2(h)(8))
  • This regulatory rule means the anti-churning rules do NOT apply solely because old target and new target are treated as the same corporation for state law purposes or for certain Code purposes (such as employment tax or employee benefit plan continuity).
  • The deemed purchase of assets by new target is treated as an acquisition from an unrelated person for anti-churning purposes, regardless of the continuity of corporate identity between old and new target.
• Anti-churning rules can apply if new target is actually related to old target under the 20% test. Although new target is not treated as old target, anti-churning rules may still apply if new target is "related" to old target under the 20% common ownership test in Treas. Reg. § 1.197-2(h)(6)(i)(A).
  • This typically occurs when the same shareholders (or a controlling group) own both old target and new target in a manner that creates 20% or greater common ownership.
  • EXAMPLE. Individual A owns 100% of old target. Individual A also owns 25% of purchasing corporation P. New target is deemed to be related to old target because Individual A's 25% ownership of P creates a 20%+ common ownership relationship between old target and new target (through Individual A's connection to both).
  • If new target and old target are related under this 20% test, the anti-churning rules apply to any § 197 intangibles that old target held during the transition period.

Step 14C. Gain Recognition Exception

• Full gain recognition by transferor creates an exception to anti-churning denial. If a taxpayer acquires an intangible from a person who would not be a related person but for the substitution of "20%" for "50%" in the related person test, the intangible qualifies for the gain-recognition exception if the transferor recognizes the full amount of the gain on the transfer. (Treas. Reg. § 1.197-2(h)(9))
  • The rationale is that the related-party concern (shifting basis without tax cost) is not present if the transferor fully recognizes and pays tax on the gain.
• Most § 338 elections automatically satisfy the gain recognition exception. In a § 338 transaction, old target's recognition of gain on the deemed asset sale satisfies the gain-recognition exception because old target is treated as fully recognizing gain on the deemed sale of all its assets (including § 197 intangibles). (Treas. Reg. § 1.197-2(h)(9))
  • This means that even if old target and new target are related under the 20% test, the anti-churning rules will not deny amortization basis for target's § 197 intangibles because old target recognizes full gain on the deemed asset sale.
• Limitations on the automatic gain recognition exception.
  • The exception applies only to the extent old target actually recognizes gain. If a § 338(h)(10) election produces net losses on the deemed asset sale, or if net operating losses offset the gain, the exception may not apply to assets that do not produce recognized gain.
  • The exception does not apply to assets for which gain is not recognized under § 338 (such as certain contingent liabilities or assets with built-in losses that offset built-in gains).
• CAUTION. Verify that the deemed sale produces recognized gain on the intangibles at issue. Before concluding that the gain recognition exception applies, confirm that the specific § 197 intangibles generated recognized gain in the deemed asset sale. If an intangible has a basis equal to or greater than its fair market value, no gain is recognized and the exception may not apply to that specific asset.
  • Cross-reference Step 9 for ADSP computation and gain allocation among asset classes.

Step 15. S Corporation-Specific Issues

Step 15A. § 338(h)(10) Eligibility and Election Requirements for S Corporations

• Target must be an S corporation immediately before the acquisition date. A § 338(h)(10) election is available only if target was an S corporation under § 1361 immediately before the acquisition date. (Treas. Reg. § 1.338(h)(10)-1(b)(4))
  • If target's S election terminated before the acquisition date (for example, due to excess passive investment income or ineligible shareholder acquisition), § 338(h)(10) is not available.
  • If NO, target is not an S corporation on the acquisition date → § 338(h)(10) is unavailable. Analyze whether § 338(g) or § 336(e) might apply instead.
• All S corporation shareholders must consent to the election. Every shareholder of the S corporation must consent to the § 338(h)(10) election, including non-selling shareholders who retain their shares and shareholders who hold shares that are not acquired by purchasing corporation. (Treas. Reg. § 1.338(h)(10)-1(c)(3))
  • The consent requirement is broader than the selling-group-only consent typical of consolidated group § 338(h)(10) elections.
  • A single dissenting shareholder can block the election.
  • Obtain written consent from each shareholder before the filing deadline (15th day of 9th month after acquisition date).
• S election continues through the close of the acquisition date. For purposes of § 338(h)(10), target's S corporation election remains in effect through the close of the acquisition date. (Treas. Reg. § 1.338(h)(10)-1(d)(3)(i))
  • This means the deemed sale of assets and the deemed liquidation are treated as occurring while target is still an S corporation.
  • All tax consequences of the deemed sale flow through to the S corporation shareholders under § 1366.

Step 15B. Tax Consequences at the Shareholder Level

• S corporation shareholders take pro rata share of deemed sale consequences. Each S corporation shareholder takes into account his or her pro rata share of the deemed sale gain or loss under § 1366(a) and adjusts stock basis under § 1367. (Treas. Reg. § 1.338(h)(10)-1(d)(5)(i))
  • The character of each item of deemed sale gain or loss passes through to shareholders as if the item were realized directly by the S corporation in an actual asset sale.
  • Each shareholder's basis in S corporation stock is adjusted under § 1367(a)(1) for their share of deemed sale gain (increased) or loss (decreased).
• Deemed liquidation proceeds are treated as received by shareholders in exchange for stock. The deemed liquidation distribution under § 338(h)(10)(B) is treated as received by the S corporation shareholders in exchange for their stock under § 331(a). (Treas. Reg. § 1.338(h)(10)-1(d)(5)(ii))
  • Shareholders recognize capital gain or loss equal to the excess of the deemed distribution amount over their adjusted basis in S corporation stock (after basis adjustments for the deemed sale).
  • Non-selling shareholders who do not transfer their stock to purchasing corporation are treated as receiving their pro rata share of the deemed liquidation distribution and must recognize gain or loss accordingly.
• TRAP. Non-selling shareholders bear tax liability without receiving cash. Because all shareholders must consent to the election and all shareholders take into account their pro rata share of the deemed sale consequences, non-selling shareholders may recognize taxable gain without receiving any cash proceeds from the transaction.
  • Structure the transaction to ensure non-selling shareholders receive sufficient cash or notes to cover their tax liability.
  • Alternatively, negotiate a tax reimbursement agreement from selling shareholders or purchasing corporation.

Step 15C. Built-In Gains Tax Under § 1374

• § 1374 built-in gains tax does not apply to the § 338(h)(10) deemed sale. The deemed sale under § 338(h)(10) is treated as occurring while the S corporation election is still in effect. Because § 1374 imposes corporate-level tax only on recognized built-in gains from the corporation's C corporation years that are recognized during the recognition period when the corporation is NOT an S corporation, the deemed sale gain is not subject to § 1374 tax. (Treas. Reg. § 1.338(h)(10)-1(d)(3)(i), § 1374(d)(7) defining the recognition period)
  • The deemed sale occurs while S election is in effect, so the § 1374 tax mechanism does not apply.
• CAUTION. Verify whether § 1374 applies to actual recognized built-in gain in the short taxable year. If target had been a C corporation within the 5-year recognition period, any actual recognized built-in gain during the short taxable year ending on the acquisition date (before the deemed sale) remains subject to § 1374.
  • EXAMPLE. Target (an S corporation since Year 1) has net unrealized built-in gain from its C corporation years. In the short taxable year ending on the acquisition date, target sells an asset and recognizes actual built-in gain. That actual gain is subject to § 1374 at the corporate level because it is recognized while the S election is in effect but § 1374 applies to S corporations within the recognition period. The deemed sale gain under § 338(h)(10) is separate from this actual gain and is not subject to § 1374.
  • If target's S election terminates before the deemed sale completes (an unusual circumstance), the deemed sale gain could become subject to § 1374.

Step 15D. QSP Issues Unique to S Corporation Acquisitions

• S corporation status prevents creeping acquisitions by corporate purchasers. An S corporation cannot have a corporate shareholder under § 1361(b)(1)(B). Therefore, a creeping acquisition by a corporate purchaser is generally impossible because the first share purchased by a corporation terminates the S election.
  • If purchasing corporation is a C corporation or an entity taxable as a C corporation, it cannot acquire S corporation shares in stages. The first acquisition by a corporate shareholder terminates the S election, after which target becomes a C corporation.
  • For a corporate purchaser to acquire an S corporation in a QSP, it must acquire at least 80% of the S corporation stock all at once from individual or eligible trust shareholders.
• Non-corporate purchasers cannot make a QSP. If the purchaser is an LLC taxable as a partnership or a partnership, no QSP can occur because the purchaser is not a corporation. (§ 338(d)(3) defines purchasing corporation to mean any corporation making a qualified stock purchase)
  • If purchaser is a non-corporate entity and the parties desire asset-sale treatment, only § 336(e) might be available (and only if the seller makes the election).
  • Cross-reference Step 4 for QSP requirement analysis and Step 7 for § 336(e) election availability.

Step 15E. § 336(e) Elections for S Corporations

• All S corporation shareholders must enter into a binding written agreement. A § 336(e) election for an S corporation target requires a binding written agreement signed by all S corporation shareholders and the S corporation itself. (Treas. Reg. § 1.336-2(h)(3))
  • The agreement must be entered into on or before the due date (including extensions) of the S corporation's tax return for the taxable year that includes the disposition date.
  • A copy of the agreement must be attached to the S corporation's tax return for the year of the disposition.
• New S election must be made for new target if pass-through treatment is desired. If the acquirer wants the new target to be an S corporation, a new S election must be filed on Form 2553 because the § 336(e) deemed liquidation terminates the original S corporation. (Treas. Reg. § 1.336-2(b)(1)(ii), The Tax Adviser, May 2018)
  • New target must satisfy all S corporation eligibility requirements under § 1361(b) including shareholder identity, number of shareholders, and single class of stock.
  • The deemed liquidation may trigger recognition periods to restart for § 1374 purposes if new target has former C corporation assets with built-in gain.
• If acquirer is noncorporate and wants pass-through, must use actual liquidation. If the acquirer is a noncorporate entity and desires pass-through taxation, the acquirer must actually liquidate target into an LLC or other pass-through entity under §§ 331 and 336 rather than under §§ 332 and 337. (Cross-reference Step 6 discussion of this structural trap)
  • A liquidation under § 332 (parent-subsidiary) is not available because the parent is not a corporation.
  • The § 331/336 route produces taxable gain or loss at the corporate level and capital gain or loss at the shareholder level.

Step 16. Step-Transaction Doctrine and Multi-Step Acquisitions

Step 16A. Rev. Rul. 90-95 Framework

• Multi-step transactions may be integrated but stock purchase accorded independent significance. In Rev. Rul. 90-95 (1990-2 C.B. 67), the IRS addressed a multi-step transaction in which (i) acquiring corporation formed a wholly owned subsidiary, (ii) the subsidiary merged into target with target shareholders receiving cash, and (iii) target then merged up into acquiring corporation.
  • The IRS ruled that the step-transaction doctrine disregarded the transitory subsidiary and treated the first step as a direct stock purchase by acquiring corporation from target shareholders.
  • However, the stock purchase was accorded independent significance from the subsequent upstream merger.
  • Result. The transaction was treated as a qualified stock purchase followed by a § 332 liquidation, which produces a carryover basis result in target's assets if no § 338 election is made.
• Practical implication for QSP protection. Rev. Rul. 90-95 protects QSP status even when steps are integrated under the step-transaction doctrine. The stock acquisition retains its character as a QSP even if the subsequent steps are collapsed, provided the stock acquisition has independent business purpose and economic substance.

Step 16B. Rev. Rul. 2001-46 and the § 338(h)(10) Override

• Integration may produce reorganization treatment for multi-step transactions. In Rev. Rul. 2001-46 (2001-42 I.R.B. 1), the IRS addressed multi-step transactions where a stock acquisition viewed independently is a QSP, but integration of all steps would qualify the overall transaction as a reorganization under § 368(a).
  • For transactions with acquisition dates after September 24, 2001, the IRS generally integrates steps to find reorganization treatment where the overall transaction satisfies the requirements of a reorganization.
  • Without special protection, this integration could destroy QSP status because a reorganization does not constitute a purchase for § 338 purposes.
• Treas. Reg. § 1.338(h)(10)-1(c)(2) provides an explicit override for § 338(h)(10) elections. Notwithstanding the general rule in Treas. Reg. § 1.338-3(c)(1)(i) that related transactions may affect QSP status, a § 338(h)(10) election may be made where P's acquisition of T stock viewed independently is a QSP and after the stock acquisition T merges or liquidates into P, whether or not the step-transaction doctrine would treat the integrated transaction as a reorganization. (Treas. Reg. § 1.338(h)(10)-1(c)(2))
  • If a § 338(h)(10) election is made, the acquisition is treated as a QSP and NOT as part of a reorganization.
  • This regulatory override gives taxpayers certainty that § 338(h)(10) treatment is available even when the overall transaction looks like a reorganization.
• If § 338(h)(10) is NOT made and step-transaction integration applies, the transaction is a reorganization. If the parties do not make a § 338(h)(10) election and the IRS successfully applies the step-transaction doctrine to integrate the steps, the transaction may be treated as a reorganization with carryover basis in target's assets.
  • If the parties desire stepped-up basis, they must make the § 338(h)(10) election to invoke the override.
  • If carryover basis is desired, the parties may choose not to make the election and accept reorganization treatment.

Step 16C. Transition Relief for Rev. Rul. 2001-46

• Acquisitions on or before September 24, 2001 receive automatic protection. For acquisition dates on or before September 24, 2001, the IRS will not challenge a § 338(h)(10) election even if the step-transaction doctrine would treat the integrated transaction as a reorganization. (Rev. Rul. 2001-46)
• Binding agreements entered on or before September 24, 2001 receive similar protection. For binding agreements entered into on or before September 24, 2001, the IRS provides comparable protection for § 338(h)(10) elections.
• Taxpayer must not take a position inconsistent with QSP treatment. The transition relief is conditioned on the taxpayer not taking any position inconsistent with the QSP treatment (for example, treating the transaction as a reorganization for some purposes and a QSP for others). (Rev. Rul. 2001-46)

Step 16D. Risk for § 338(g) Elections in Multi-Step Transactions

• TRAP. No comparable explicit override exists for § 338(g) elections. The Treas. Reg. § 1.338(h)(10)-1(c)(2) override is specific to § 338(h)(10) elections. If a multi-step transaction involving a freestanding C corporation target would be a reorganization when integrated under the step-transaction doctrine, the QSP status for a § 338(g) election may be at risk.
  • Treas. Reg. § 1.338-3(c)(1)(i) provides that if a stock acquisition viewed independently is a QSP, that status is generally determined without regard to related transactions, BUT if the step-transaction doctrine would treat the integrated transaction as a reorganization, the QSP may be recharacterized.
  • The § 338(h)(10) override in Treas. Reg. § 1.338(h)(10)-1(c)(2) has no analogue for § 338(g).
• Mitigation strategies for § 338(g) transactions.
  • Document the stock acquisition as having an independent business purpose separate from any subsequent merger or liquidation.
  • Ensure there is meaningful economic substance to the stock acquisition step (e.g., target operates as a subsidiary for a period before any downstream merger).
  • Consider whether the overall transaction could qualify as a reorganization and whether the parties would be better served by § 338(h)(10) (if available) given the stronger regulatory protection.
  • If § 338(h)(10) is unavailable (e.g., target is a freestanding C corporation), evaluate the reorganization risk against the benefit of the § 338(g) election.

Step 16E. Planning Considerations for Multi-Step Acquisitions

• When possible, document the stock acquisition as having independent business purpose. The stronger the business purpose for the stock acquisition as a separate step, the less likely the IRS is to apply step-transaction integration.
  • Factors supporting independent significance include (i) target operates as a separate subsidiary for a meaningful period after acquisition, (ii) the stock acquisition is negotiated and documented separately, (iii) there is independent economic consideration for the stock, and (iv) the subsequent merger serves a separate business purpose (e.g., integration of operations).
• If § 338(h)(10) is available, the regulatory override provides stronger protection. For consolidated group subsidiaries and S corporations, the Treas. Reg. § 1.338(h)(10)-1(c)(2) override eliminates step-transaction risk for § 338(h)(10) purposes.
  • If the parties desire stepped-up basis and § 338(h)(10) is available, it is generally preferable to § 338(g) in multi-step transactions because of this override.
  • Cross-reference Step 5 for § 338(g) vs. § 338(h)(10) comparison.
• CAUTION. Avoid transitory steps with no independent purpose. Steps that serve no purpose other than to create QSP technical compliance (such as a transitory subsidiary that exists solely to merge into target) are most vulnerable to step-transaction integration.
  • Each step should have a plausible business purpose that can be documented in board resolutions and transaction materials.

Step 17. Documentation, Reporting, and Filing Obligations

Step 17A. Form 8023 Filing Requirements

• Form 8023 is used to make § 338(g) or § 338(h)(10) elections. Form 8023 (Elections Under § 338 for Corporations Making Qualified Stock Purchases) must be filed to effectuate either type of § 338 election. (Instructions for Form 8023 (Rev. Oct. 2023))
  • The form must be filed by the 15th day of the 9th month beginning after the month in which the acquisition date occurs.
  • File Form 8023 with the Internal Revenue Service Center in Ogden, Utah (OTSA Mail Stop 4916) or by e-fax to 844-253-9765.
  • For § 338(g) elections. Filed by the purchasing corporation only.
  • For § 338(h)(10) elections. Filed jointly by purchasing corporation AND the selling consolidated group parent, selling affiliate, or all S corporation shareholders (as applicable).
• One Form 8023 may cover multiple targets. A single Form 8023 may be used for multiple targets if (i) all targets have the same acquisition date, (ii) all targets were members of the same pre-acquisition affiliated group, and (iii) all targets become members of the same post-acquisition affiliated group. (Instructions for Form 8023 (Rev. Oct. 2023))
  • If these conditions are not satisfied, a separate Form 8023 must be filed for each target.
• Late filing relief is available under Rev. Proc. 2003-33. Rev. Proc. 2003-33 provides an automatic 12-month extension from the date of discovery of the failure to file Form 8023. (Rev. Proc. 2003-33, 2003-1 C.B. 803)
  • The automatic extension requires a statement with the specific heading "AUTOMATIC EXTENSION UNDER REV. PROC. 2003-33" filed by all persons required to file the election under penalties of perjury.
  • § 9100 relief is also available for situations that do not qualify for the automatic extension. A § 9100 ruling request must demonstrate that the taxpayer acted reasonably and in good faith and that granting relief will not prejudice the interests of the government.
• TRAP. Missing the filing deadline is fatal to the election absent relief. If Form 8023 is not filed by the deadline and no late filing relief is obtained, the § 338 election is ineffective and cannot be made in a subsequent year. The target's assets will retain carryover basis.
  • Calendar the filing deadline at the outset of the transaction and confirm timely filing with proof of delivery.
  • If the deadline is missed, file for automatic relief under Rev. Proc. 2003-33 immediately upon discovery.

Step 17B. Form 8883 Filing Requirements

• Form 8883 is the Asset Allocation Statement under § 338. Both old target and new target must file Form 8883 (Asset Allocation Statement Under § 338) with their respective income tax returns for the taxable year that includes the acquisition date. (Instructions for Form 8883 (Oct. 2017))
  • Form 8883 shows the ADSP or AGUB computation and the allocation among the seven asset classes under § 1060 (Class I through Class VII).
  • Old target's Form 8883 reports the deemed sale proceeds and gain or loss on each asset class.
  • New target's Form 8883 reports the AGUB allocation and stepped-up basis in each asset class.
• Amended Form 8883 is required for post-acquisition adjustments. If ADSP or AGUB increases or decreases after the first taxable year (for example, due to contingent consideration resolution or purchase price adjustments), the affected target must file an amended Form 8883. (Instructions for Form 8883 (Oct. 2017))
  • Cross-reference Step 10 for ADSP/AGUB increase and decrease mechanics.
• Foreign purchasing corporations file Form 8883 with Form 5471. If the purchasing corporation is a foreign corporation, Form 8883 is filed with Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) by the U.S. shareholders. (Instructions for Form 8883 (Oct. 2017))

Step 17C. § 336(e) Election Documentation

• § 336(e) elections use a binding written agreement, not Form 8023. Unlike § 338 elections, § 336(e) elections are made through a binding written agreement executed by the parties rather than through a specific IRS election form. (Treas. Reg. § 1.336-2(h))
  • The written agreement must be entered into on or before the due date (including extensions) of the tax return for the taxable year that includes the disposition date.
  • An election statement must be attached to the relevant tax returns.
• For S corporations, the agreement is signed by all shareholders and the S corporation. All S corporation shareholders must sign the binding written agreement, which must then be attached to the S corporation's tax return for the disposition year. (Treas. Reg. § 1.336-2(h)(3))
  • Cross-reference Step 15E for S corporation § 336(e) specific requirements.
• For non-S corporations, the agreement is attached to both seller's and target's returns. The written agreement must be attached to the income tax return of both the seller and the target for the taxable year that includes the disposition date. (Treas. Reg. § 1.336-2(h)(1))
• Protective election is permitted. A protective § 336(e) election may be made to preserve the parties' position in case the transaction is later determined not to qualify as a QSD. The protective election should state that it is conditioned on the transaction being treated as a qualified stock disposition. (Treas. Reg. § 1.336-2(h)(4))
  • If the transaction is ultimately not a QSD, the protective election has no effect.
  • If the transaction is ultimately a QSD, the protective election becomes effective.

Step 17D. Other Reporting Considerations

• New target retains the same EIN as old target. For federal tax purposes, new target is treated as a continuation of old target and retains the same employer identification number. (Treas. Reg. § 1.338-1(b)(3)(iii))
  • Do not apply for a new EIN for new target.
  • Employment tax records, employee benefit plans, and other EIN-dependent systems continue without interruption.
• Old target files a short-period return through the acquisition date. Old target must file an income tax return for the short taxable year beginning on the first day of the taxable year and ending on the acquisition date. (Treas. Reg. § 1.338-1(b)(1))
  • The short-period return reports the deemed sale gain or loss and the final tax attributes of old target.
  • Old target's taxable year ends at the close of the acquisition date for purposes of § 338.
• New target files a return beginning the day after the acquisition date. New target files its first income tax return beginning on the day after the acquisition date. (Treas. Reg. § 1.338-1(b)(2))
  • If the acquisition date is the last day of the taxable year, new target's first taxable year begins on the following day.
  • If the acquisition date is not the last day of the taxable year, new target has a short first taxable year.
• Form 8594 is NOT required for § 338 elections. Form 8594 (Asset Acquisition Statement) is required for actual asset purchases under § 1060 but is NOT required for § 338 deemed asset sales because Form 8883 serves the same function. (Instructions for Form 8594)
  • Form 8594 IS required if the parties structure the transaction as an actual asset purchase rather than a § 338 deemed asset sale.
  • TRAP. Do not file Form 8594 for a § 338 transaction. Filing the wrong form may create confusion and invite IRS scrutiny.
• Record retention requirements. Maintain the following records for at least the statute of limitations period (generally 3 years from the filing date of the relevant return, but consider 6 years for substantial omissions and indefinite retention for carryover attribute issues).
  • Fair market value appraisals for all asset classes included in the Form 8883 allocation.
  • ADSP and AGUB computation workpapers.
  • Documentation of the acquisition date computation (including QSP tracing).
  • QSP or QSD analysis with capitalization tables showing ownership percentages.
  • Election forms (Form 8023 or § 336(e) written agreement) and proof of timely filing.
  • Gain recognition election schedules and related party analysis for anti-churning purposes.
  • Cross-reference Step 9 for asset allocation documentation requirements.