338 (h)(10) selling company

Nice summary, HenryDavid. Now as a public service, you can make this post a highly searched and read post well into the future by adding a scenario where the selling S corp has lots of 1245 recapture and/or, say, cash method receivables. Then one last scenario for a C corp sale, with and without those elements.

It's about time to say that I'm glad HenryDavid has joined us. His posts are always very good.

If I'm the seller and you agree to a stock sale and then switch to 338h10...we're re-negotiating.

Right. But big deal. Then as the seller, you ask for a gross-up as part of that negotiation.

If I'm the seller and you agree to a stock sale and then switch to 338h10...we're re-negotiating.

No different than if buyer agrees to a stock sale, but then says, “I want it to be an asset sale.” Same comment as above, which is the same as SJR’s: Seller negotiates and asks for a gross-up.

And if the parties agree to an asset sale, but then the buyer says, “I want it to be a stock sale with an (h)(10) election,” then so what. Both of these are asset sales.

And if the parties haven’t agreed to anything yet, then assets vs. stock would be part of the initial negotiation, not any re-negotiation.

Other than the point of keeping regulartory and licensing stuff the same, I've just never understood a reason.

Don’t forget contracts, which is a pretty major consideration. Especially if there’s hundreds or thousands of them. And don’t forget leases. And don’t forget loans that will be assumed. If there are issues with assignability of these things, a pure asset sale might be out of the question.

The issue JR1 is describing isn’t one we’d attribute to an (h)(10) election per se. It is the parties perhaps having already agreed to a straight stock sale and then one of those two parties later changes their mind. That is really the issue. And it’s not even the issue in OP’s case for two possible reasons. First reason is that the parties may not have agreed to anything yet (OP simply says, “I was originally thinking it was going to be an asset sale”). Second reason is that if they had agreed to anyting, it seems they agreed to an asset sale. So changing from an asset sale to an asset sale is no change at all.

I think the ultimate taxpayer will recognize gain/loss (1) when there is a deemed sale from the old target to the new target and (2) when it receives liquidating distribution. When the shareholder receives the liquidating distribution (aka sales proceeds), there is a chance that he might have a capital loss if his basis in the liquidating s-corp is higher than the actual sales proceeds it receives.

Right, two steps involved. Deemed sale of assets. Then a deemed liquidation. HenryDavid understands this. He’s saying S-stock basis will increase for the pass-thru gain. And if there is a caital loss to the shareholder on the liquidation, as may sometimes happen, as you suggest, it will offset the pass-thru gain, assuming that pass-thru gain includes at least an equivalent amount of cap/1231 gain. (We’d also have an offset whereby we could use the capital loss on liqudation if the shareholder has some personal cap gains from some other sources). And HenryDavid did say, “Assuming [pass-thru] gains are primarily capital…” And he probably said that because OP said 95% of the sales price would be allocated to goodwill.

As you know, ADSP may not be the same as the actual sales proceeds if the target has liabilities. No?

Yeah, but that’s only because a stock sale an asset sale are different constructs. Remember, the S-shareholders already got the cash, because it was a stock sale. What they got for their stock was the equity value…asset value minus liabilities. With the election, we create a fiction so that our asset sale, and subsequent liquidation, mirrors a stock sale. Hence the need to gross up inside asset value by the liabilities. And when we do just that, and run through an asset sale scenario, and then a deemed liquidation, we end up at the same place.

If a Company with $40k of liabilities has an equity value is $60k, the shareholders get $60k if they sell their stock. If we were to construct a parallel asset sale, we’d say ADSP is $100k. Corp is deemed to collect that $100k, then deemed to pay-off the $40k of liabilities and then is deemed to distribute the $60k remainder. In both cases, shareholders got $60k of cash.

Thanks, folks. I guess I do understand it better than I thought, and the reasons about licenses and contracts make perfect sense. Many in the medical community have those issues with the insurance co's. . .

For us, it's government contractors.

Thanks everyone for the great input.

Massachusetts has placed a moratorium on Home Health Agency (ie visiting nurses) being eligible for state Medicaid certification. So the buyer insisted it had to to be a stock sale. They needed an existing license/certification.

There was an offer and then we would add the cash and receivable less any liabilities at time of closing. Then during the due diligence the buyer CPA asked if the seller would be open to discussing the 338h election. They implied we just need to discuss the purchase price allocation.

When I assumed any sale would be an asset sale, I was thinking most of the price would be goodwill with a minimum amount to furniture and fixtures (no real estate involved). So what that CPA says makes sense.

However, the seller like many medical service companies is cash basis. I think that means our receivables are now going to be ordinary income instead of cap gains. Since most insurance companies pay 30-60 days out, the receivable number is probably going to be in the $200k to $300k range

If this was a pure stock sale am I correct in thinking the entire amount including the adjustment for AR would be cap gains? Now I think we should add say 15% to the A/R number to cover the ordinary portion

Thanks for all the input. I now have a much better feel for 338 (h) (10) then i did a few days ago

If this was a pure stock sale am I correct in thinking the entire amount including the adjustment for AR would be cap gains?. Yes.

They implied we just need to discuss the purchase price allocation.

From what I've seen, most buyers who are sophisticated enough to request the 338 election are not going to pass on it (from what your'e indicating, the buyer would effectively have an immediate income pickup from the cash-basis receivables as soon as they are collected, no doubt the seller is making the buyer pay for the receivables), and the tax-deductible intangible asset amortization is almost a necessity if there is a risk that the acquired business may not do as well as hoped (virtually no one wants a capital loss from the disposition of corporate stock). If the deal is $1.5m plus, there's no way I would advise the buyer to accept a stock purchase.

Agreeing to the 338 election is a negotiation point the seller can leverage to make the deal go through. If the seller's cash-tax increases from the cash-basis receivables, the seller can always factor that into the sale price (again, as part of the negotiation).

Now I think we should add say 15% to the A/R number to cover the ordinary portion

This is that gross-up that we’ve been talking about. And don’t forget, if you gross-up, the gross-up itself is additional consideration, resulting in more gain, and hence, more tax. So, you’d want to shoot for a gross-up of the gross-up too. And so and so forth, in a circular (or iterative) kind of way…

We had a client do a 338 h(10) election recently. Seller is our client. Do you file a final tax return for the S-Corporation that sold it's stock as a short yearned?

Wouldn't a final tax return kill the EIN? The buyer is still running payroll using the EIN of the S-Corp that sold it's stock.

Generally marked final to tell the IRS there was a taxable liquidation...the disclosure form (8023 / 8883) tells the IRS what happened.

I've seen folks go the other way, where they don't mark the return final.

Generally marked final to tell the IRS there was a taxable liquidation...the disclosure form (8023 / 8883) in the return tells the IRS what happened.

I've seen folks go the other way, where they don't mark the return final.

Short year return? The transaction closed in March of this year. Originally we planned to have the CPA for the buyer prepare the 2020 tax return and allocate income on a cut-off basis between the new shareholder and old shareholder. Gain form sale allocated to the old shareholder. I believe they did make a Qsub election .

The more I am thinking about it, seems like this may not be the correct way to handle?

Short period return for seller, and probably for buyer as well.

I wouldn't say there is a "cotuff"- they are two entirely separate periods and returns (there is zero carryover). Everything resets for the buyer (accounting methods, depreciable basis, etc.). From the buyer's perspective, the old accounting records for income taxes have no bearing, the buyer starts with it's beginning balance sheet = purchase price allocation.

And there is no "return" for a QSub...though perhaps (not necessarily) the buyer needs to have the QSub activity accounted for as its own trade or business (as applicable).

There may be an obvious answer to this question but I can't find anything authoritative. Does a former officer/shareholder of the selling company sign the short-period return reflecting activity up through date of sale or does an authorized signer from the buying company sign that return since they are acquiring the entity legally and own the company when the tax return is being prepared?

Usually the party responsible for the short year return is named in the sale documents. Typically it is the seller.

Thanks. Got my hands on a copy of the agreement and it was tucked away in a separate clause relating to "taxes". In this case, the buyer "shall prepare, or cause to be prepared, and file, or cause to be filed, all tax returns of the Company for all periods ending on or prior to the Closing Date..."

I more often see buyers signing the return, since they’ve become the corporate officers at the time the return is filed

Buyers usually sign when there is no short year. When there Is a short year seller’s usually. But what the agreement says is more relevant here so never mind comment. I’m reading this thread backwards.

If the buyer is making a down payment for the purchase of the S Corp. and making remaining payments over 3-4 years on a monthly basis with interest, seller reports on the installment basis. Would purchaser take over seller's S Corp. at time of sale and make any installment payments directly to the selling stockholders [who have given up their stock on a stock sale]?

Would Section 338[h][10] be available if same business is sold on the installment basis on the terms I've mentioned?

Yes. Yes.