338 (h)(10) selling company

We have an S Corp client who is selling their nursing agency company. It is pretty much a pure service business with a minimal amount of of fixed assets in the company name. I was originally thinking it was going to be an asset sale and 95% of the sales price would be towards goodwill.

But the acquiring company needs it to be a stock sale so all of the licensing, certifications, etc can easily transfer over to the buyer. I told my client it helps a little but we we were looking at all capital gains rates anyway because we would be selling goodwill so do not let them negotiate a lower sales price. My thoughts were the main issue was going to be make sure they knew we were going to use the close the books method for allocating income.

In the due diligence they are mentioning 338(h)(10). This just might be a boilerplate checklist but I wanted to get familiar with this. If the buyer is going to want 338(h)(10) does that mean the existing S Corp will end at the sales date and no closing of the books is needed? I know legally it is a stock sale but the buyer gets to treat it as an asset sale and gets the step up. But does the seller have to treat it as an asset sale as well.

I think that's the point of it, the seller has a stock sale, while the buyer has an asset purchase.

The transaction is an asset sale for both buyer and seller for federal income tax purposes. But for all other purposes state and local the transaction is a stock sale for both buyer and seller.

What happens is the seller has sold the assets and is deemed to liquidate the company immediately after. Usually because the company is later treated as a QSUB. I've never seen a 338(h)(10) transaction do a full year tax return. They seem to always liquidate for some reason or another, but it may depend on the particular transaction. I'd have to research and am not sure.

Thanks for reminding me why these never made sense to me? Why not just do an asset sale, then?

It really is a win for the buyer, with no real advantages to the seller. Here is an article that talks about how the S corp. is deemed liquidated.

The S corporation (Old Target) is treated as if it had transferred all its assets to a new S corporation (New Target) and then liquidated by distributing the proceeds to the S corporation shareholders. The gain on the deemed sale under Sec. 338(h)(10) is reported on the target’s final S corporation return and is therefore taken into account under Secs. 1366 and 1367 to determine the target shareholder’s basis in the target stock and the resulting gain or loss on the deemed distribution of proceeds in a transaction that may be characterized as a reorganization, a redemption, or a liquidation.

https://www.thetaxadviser.com/issues/20 ... text=338(h)(10)%20election,from%20undisclosed%20and%20unknown%20liabilities

Why not just do an asset sale, then?

Because of what the OP said:

But the acquiring company needs it to be a stock sale so all of the licensing, certifications, etc can easily transfer over to the buyer.

No need to get new licenses, no need to re-title assets, no need to re-negotiate contracts (hopefully, depending on the terms of the contracts)…

Good for seller as well - passes the corporation and all of its...history to a new owner

Good for seller as well - passes the corporation and all of its...history to a new owner

re history... just to clarify - tax attributes will be wiped out.

To OP, the Seller must renegotiate the purchase price if the 338 election were to happen. The buyer gets step up in basis of the assets it purchased and will enjoy depreciation benefit (plus, Section 179 immediate expensing and bonus depreciation after that). Moreover, the seller potentially has a double layer of taxation - (1) the seller will recognize any gain (or loss rarely) on the old target's deemed sale of assets to a new target S- corp (this is a case for S-Corp, if the target was a C-Corp then g/l picked up by the old target) then (2) the seller will also have to recognize any gain/loss upon the liquidation of the old target.

Plus, since the target is an S-corp, the buyer must purchase all of the stocks (or at least 80%) at once otherwise - the transaction may not qualify as a QSP...

Hope this helps and make sure to adjust the purchase price!

Seller is an S corp. No double tax on sale.

Seller is an S corp. No double tax on sale.

sorry you're right no second layer tax on the seller since it's scorp but then - in this case, a potential second layer tax would land on the ultimate shareholder(s) (depending on the outside basis), no?

potentially.

Good for seller as well - passes the corporation and all of its...history to a new owner

re history... just to clarify - tax attributes will be wiped out.

INCOME tax attributes will be wiped out for federal income tax purposes. Possibly for state as well, if the state conforms.

Seller is an S corp. No double tax on sale.

sorry you're right no second layer tax on the seller since it's scorp but then - in this case, a potential second layer tax would land on the ultimate shareholder(s) (depending on the outside basis), no?

Assuming gains are primarily capital, should NOT be a second layer of tax (outside basis will increase by the gains recognized), and taxpayer will have a gain/loss on the liquidation according to basis at time of liquidation. Shareholder should only pay tax once on the sale proceeds to the extent they exceed the shareholder's outside basis.

Perhaps the intent was to say there could be a higher gain recognized by the shareholder than reported on the S Corp final K-1?

But you're potentially converting what would be all cap gain on the seller side to deprec recap, etc. when you flip to an asset sale. Other than the point of keeping regulartory and licensing stuff the same, I've just never understood a reason. If I'm the seller and you agree to a stock sale and then switch to 338h10...we're re-negotiating.

For buyers, the attractions are:
a) No need to novate contracts, get new licenses or EIN, etc.
b) Get "step up" basis in assets for depreciation and amortization purposes.

Whether we represent the buyer or the seller, we model tax consequences of stock sale vs asset sale. It can be a negotiating point.

But you're potentially converting what would be all cap gain on the seller side to deprec recap, etc. when you flip to an asset sale. Other than the point of keeping regulartory and licensing stuff the same, I've just never understood a reason. If I'm the seller and you agree to a stock sale and then switch to 338h10...we're re-negotiating.

As we discussed above, a 338h10 election gives a nice reboot to the target company so it is attractive to the buyer for depreciation/amortization purposes - so from the seller side, it is important to get a fair adjustment for the benefits the buyer is receiving. The seller has no incentive to welcome this.

Frequently it's deal or no deal.

Seller is an S corp. No double tax on sale.

sorry you're right no second layer tax on the seller since it's scorp but then - in this case, a potential second layer tax would land on the ultimate shareholder(s) (depending on the outside basis), no?

Assuming gains are primarily capital, should NOT be a second layer of tax (outside basis will increase by the gains recognized), and taxpayer will have a gain/loss on the liquidation according to basis at time of liquidation. Shareholder should only pay tax once on the sale proceeds to the extent they exceed the shareholder's outside basis.

Perhaps the intent was to say there could be a higher gain recognized by the shareholder than reported on the S Corp final K-1?

I disagree but please correct me if I'm wrong. 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. As you know, ADSP may not be the same as the actual sales proceeds if the target has liabilities. No? That's what I was getting at and sorry for the confusion my previous comments may have caused... but pls correct me if I'm wrong. Otherwise, have a great weekend.

In numbers - s Corp inside tax basis = $100, sell for $200. S Corp has $100 gain (assume capital).

If shareholder outside basis = inside basis (s Corp since inception, never any distributions > basis, etc), shareholders basis increases from $100 to $200. Sale proceeds were $200. No gain on liquidating distribution.

If shareholders stock basis < inside basis, for example $50, his basis at the time of liquidation would be $150 ($50 Plus $100 gain). Gain on liquidation = $50. Total taxable income recognized by shareholder = $150.

If shareholder basis > inside basis, for example, $150, basis at the time of liquidation would be $250. Loss on liquidation = $50. Total taxable income recognized by shareholder = $50.

In any scenario, there is no “second layer of tax”. You should calculate the transaction gain based on what the shareholder will ultimately receive. The shareholder would be indifferent in all of them (assuming essentially all LTCG which is what the orgifinal post says) if the assets were sold for $200 (338h10), or if the tax treatment was a sale of stock for $200.