When purchasing a business owned by a corporation, there are two basic choices. The buyer can buy the stock (and thus the target corporation) from the shareholders or buy the business and other assets from the target corporation.  Buying the assets means leaving the target corporation behind with the seller, usually to be eventually dissolved and liquidated.

The seller typically prefers to sell the stock. Selling stock usually means capital gains tax treatment for the seller and may avoid “double tax” and depreciation recapture issues resulting from the sale of assets by the target corporation and distribution of the sale proceeds to the seller’s shareholders.

The buyer typically prefers to buy assets. A purchase of assets will give the buyer a new tax basis in the assets acquired, resulting in tax savings for the buyer going forward.  A purchase of assets also allows the buyer to pick and choose which assets it will buy and which liabilities it will assume and which of each it will leave behind with the target corporation.

One of the disadvantages of an asset purchase is that it often requires assignment of each asset and assignment and assumption of each contract, lease or license to which the target corporation is a party. A purchase of stock of the target corporation will avoid the need for assignments of each asset and may avoid the need to obtain consent to the sale from at least some other parties such as certain licensing agencies and certain parties to the target corporation’s contracts.

A buyer would like to have it both ways, to acquire the stock of the target corporation while receiving the tax benefits of an asset purchase. There are, in fact, two sections in the Internal Revenue Code that allow a buyer and seller to agree to do just that.  The buyer can have it both ways if section 336(e) or section 338(h)(10) of the Internal Revenue Code applies to the purchase transaction.  The seller must agree to apply either 336(e) or 338(h)(10), however.  The buyer cannot elect unilaterally to apply section 336(e) or section 338(h)(10).

If the target corporation is a S Corporation for tax purposes, is a corporation which is a member of a consolidated group, or a corporation 80% owned by another domestic corporation, and if certain other requirements are met, section 336(e) or 338(h)(10) of the Internal Revenue Code and related regulations allow elections for this purpose. Under section 336(e), the seller and the target corporation being sold must agree to file an election to have the stock sale treated as an asset sale for Federal income tax purposes.  Under section 338(h)(10), the seller and the buyer must make a joint election to have the stock sale treated as an asset sale for Federal income tax purposes.

338(h)(10) applies to situations where the buyer is a corporation. Under 336(e) the buyer(s) need not be a corporation.  For income tax purposes the target corporation is deemed to have liquidated and terminated but for corporate law purposes the target corporation continues as before.  Of course, the seller must be willing to accept the tax consequences of a deemed asset sale.

Section 338(h)(10) and section 336(e) accomplish the same tax results. However, 336(e) is more user-friendly.

A decision to use section 336(e) or 338(h)(10) requires careful consideration by both seller and buyer with the help of competent tax and corporate counsel. However, in the right situation they provide additional tools to be considered in trying to reach a deal acceptable to both buyer and seller.