The health care market continues to provide mergers and acquisitions opportunities for private equity funds. In this competitive market, buyers are looking not only at overall transaction value, but also at how to structure transactions to minimize the tax consequences.
An IRC Section 338(h)(10) election offers an opportunity to treat a stock acquisition as an asset acquisition for tax purposes only, allowing for the parties to enjoy many of the additional tax benefits that come from an asset purchase, while still having a stock purchase. Regardless of which side of the negotiating table they are on, it is important for the parties to understand the costs and benefits associated with this election.
What is a Section 338(h)(10) Election?
A Section 338(h)(10) is a tax election that allows a buyer and seller to agree to treat a stock sale as an asset sale for federal income tax purposes. To make this election, generally, the following requirements must be met:
- The Buyer acquires 80% or more of the Target (vote and value of Target’s stock);
- The Target is a either a member of a consolidated group or otherwise held by a corporate shareholder or is an S corporation; and
- The Buyer and Seller agree to make this election. This will typically be a negotiated provision with the purchase agreement.
Even if requirements (1) or (2) are not met, buyers and sellers often are able to structure a transaction to have the same effect and benefits through other alternatives.
How Do You Make the Election?
A Section 338(h)(10) election is a joint election, meaning that the buyer and the stockholders of the target corporation must both agree to make the election. The parties make the election by filing Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases. The election must be filed jointly by the acquiring corporation and the common parent of the selling consolidated group, the selling affiliated corporation, or the shareholders of the S corporation by the 15th day of the ninth month after the transaction closing date. If the parties inadvertently fail to file on time, there is an automatic 12-month extension from the time the mistake is discovered.
Impact on the Buyer
A Section 338(h)(10) election has several tax benefits for the buyer. In a stock transaction, the buyer cannot amortize or take depreciation deductions for the stock, and the target company’s tax basis in its assets transfers to the buyer unchanged. With the Section 338(h)(10) election, the buyer receives a tax basis in the acquired assets equal to the fair market value.
For many health care businesses, the value is primarily in the goodwill of the business. This means that often a buyer can receive a tax basis step up equal to (or close to) the actual purchase price. This amount is then eligible to be amortized and can reduce the buyer’s tax burden by providing an additional deduction for many years after the acquisition.
Impact on the Seller
For a seller, three main issues can cause a potential negative impact from a 338(h)(10) election:
- As an asset sale, each asset is treated as being sold. As a result, the purchase price to be allocated to the assets is not just the purchase price, but instead must be grossed up for any liabilities assumed by the buyer.
- Similarly, the character of the gain is determined by looking to the actual assets at the company, not the shareholder’s treatment of the stock. With an S corporation, this will often result in some amount of depreciation recapture.
- State taxes must also be considered. Most states will follow the federal treatment of the election, but this election can result in the recognition of gain in many states (where the business operated) instead of in only one state, where the selling shareholder resides or operates.
Additionally, if the seller retains any equity, both buyer and seller may choose to implement an alternative structure in order to achieve a more favorable tax treatment.
It is common in M&A transactions for the parties to negotiate how to bear the cost of these additions to the seller’s tax bill. Modelling and assessing the full impact to the seller is critical to effectively negotiating a tax efficient transaction structure.
How Weaver Can Help
A Section 338(h)(10) election generally depends on whether the buyer’s benefit from the purchase of assets, rather than the purchase of stock, exceeds the downside for the seller. Assessing these costs and benefits requires an understanding of the tax implications of each transaction structure through an assessment of the step-up in tax basis along with the corresponding amortization and depreciation.
Whether you are a buyer or a seller, we can help you model the tax consequences of a transaction and determine the impact of making a Section 338(h)(10) election for an acquisition. Contact us for information or assistance with this election.
Partner, Tax Services
Jon Roberts, CPA, joined Weaver in 2013 and has more than 10 years of experience in public accounting with a…
Partner-in-Charge, Transaction Tax Advisory Services
Ben Sparks, JD, LLM, has more than 20 years of industry experience as a tax attorney. He has extensive experience with federal…
Partner-in-Charge, Health Care Services
For more than 10 years, Anna Stevens, CPA, CHFP, has provided accounting services to …