Stock Purchases Treated as Asset Acquisitions—Section 338, written by James T. Chudy, Esq., David Early-Hubelbank, Esq., and Harsha Reddy, Esq., of Pillsbury Winthrop Shaw Pittman LLP, analyzes in detail the elections under §338(g) and §338(h)(10), available when a purchasing corporation makes a “qualified stock purchase” of a target corporation.  

If an election is made, “old” target is treated as selling all of its assets to itself as “new” target, and “new” target is treated as purchasing those assets. “New target” has a fresh start for most federal income tax purposes, including a fair market value basis in its assets.   

A §338(g) Election is made unilaterally by the purchasing corporation, generally results in double tax, and is rare except in acquisitions of foreign targets. Section 338(h)(10) Elections, on the other hand, are common. A §338(h)(10) Election is made jointly by the seller and purchaser and is available only when the target is a subsidiary member of the consolidated or affiliated group or is a S Corporation. A §338(h)(10) Election avoids the shareholder-level tax by treating the target as having liquidated following the deemed asset sale.

This Portfolio identifies the characteristics and qualifications of a stock purchase, the timing, and the acquisition date.  It discusses the 80 percent vote and value test, exceptions to purchases, redemptions from persons unrelated to the purchasing corporations, and related party transactions. 

The authors look at the final regulations, Assumption Reinsurance Principles, and computing and allocating aggregate deemed sale price (ADSP) and adjusted grossed-up basis (AGUB).

Readers will find an introduction and background to the Consistency Rules along with the reasons for changes to the Rules and the legislative history of §338.  The mechanics of elections are also discussed. 

Stock Purchases Treated as Asset Acquisitions—Section 338 allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents including tables, charts and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
• Alternative approaches to both common and unique tax scenarios 

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which cover every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more. 

Detailed Analysis

I. Introduction and Background

A. Summary

B. Background

1. Before Section 338

2. Legislative History of Section 338

3. History of the Section 338 Regulations

C. General Utilities Repeal

D. Terms Used in this Portfolio

II. Qualified Stock Purchase

A. In General

B. Timing

1. Acquisition Date

2. 12-Month Acquisition Period

a. In General

b. Extended 12-Month Acquisition Period

C. Eligible Purchasers

1. Limited to Corporations

a. S Corporations

b. Entities Treated as Corporations

c. Disregarded Entities

2. Individuals

3. Partnerships

4. Corporation Must Be True Purchaser

D. 80 Percent Vote and Value Test

E. Purchase

1. In General

2. Exceptions to Purchase

3. Redemptions from Persons Unrelated to the Purchasing Corporation

4. Related Party Transactions

a. Acquisitions from a Related Corporation

(1) In General

(2) Special Timing Rules

b. Initial Public Offerings

c. Redemptions from the Purchasing Corporation and Related Persons

d. Section 304

5. Reverse Subsidiary Merger

a. In General

b. Overlap with Tax-Free Reorganizations

6. Leveraged Acquisitions; “Roll-Over” Investors

7. Direct Issuance of Target Stock for Cash

8. Insolvent Targets and Target Affiliates

9. Liquidating and Non-Liquidating Distributions of Target Stock

10. Deemed Purchases of Target Subsidiaries

F. Post-Acquisition Events

1. Post-Acquisition Elimination of Purchasing Corporation

2. Post-Acquisition Disposition of Target

a. In General

b. Ability to Make a § 338(g) or § 338(h)(10) Election

c. Liquidation of Target

(1) In General

(2) “Check-the-Box” Election for Target

d. Post-QSP § 368 Reorganization of Target (No § 338 Election)

(1) Yoc Heating Generally

(2) Mitigation of Yoc Heating

(3) “C” and “D” Reorganizations

e. Multi-Step Transaction Also a § 368 Reorganization

(1) Reorganization Treatment: Rev. Rul. 2001-46

(2) Overriding Rev. Rul. 2001-46 to Permit a § 338(h)(10) Election

f. Liquidation of Target Without a Qualified Stock Purchase

III. Effects of a § 338(g) Election on Old Target

A. In General

1. Foreign Target

2. Domestic Target

B. Gain or Loss Recognition for Selling Shareholders

C. Target's Gain Recognition

1. In General

2. History

a. Nonrecognition of Gain Before General Utilities Repeal

b. Full Recognition of Gain After General Utilities Repeal

3. Nonrecognition of Gain for Stock of Certain Target Affiliates

a. In General

b. Exceptions to Nonrecognition for Target Affiliate Stock

D. Target's Deemed Sale Filing

1. Target Not Included in a Consolidated Return

a. Target Is a C Corporation - Final Return

b. Target Is an S Corporation - Separate One-Day Deemed Sale Return

2. Selling Group Files a Consolidated Return

a. Single Target Includible in the Consolidated Return (but Not Common Parent) - Separate One-Day Deemed Sale Return

(1) “Selling Group”

(2) Separate Taxable Year

(3) Purchasing Corporation's Controlled Group

b. Multiple Targets Included in the Consolidated Return - Combined Deemed Sale Return

(1) In General

(2) Calculation of Deemed Sale Tax Consequences

(3) Procedure for Filing a Combined Deemed Sale Return

(4) Several Liability

c. Target Is Common Parent of Affiliated Group Filing Consolidated Returns

3. Return Filing Mechanics

a. Due Date

(1) In General

(2) Special Consolidated Return Rules

b. Estimated Taxes

c. Waivers

(1) Additions to Tax and Additional Amounts

(2) Actions Required on Timely Filed Returns

E. Calculation and Allocation of Aggregate Deemed Sale Price

1. In General

2. Calculation of ADSP

a. In General

b. Grossed-Up Amount Realized on Recently Purchased Target Stock

c. Liabilities of Old Target

(1) In General

(2) Time and Amount of Liabilities

(3) Contingent Liabilities

d. The ADSP Formula

e. Calculating Deemed Sale Tax Consequences

3. The Residual Method

4. Treatment of Target Affiliate Stock

5. Special Allocation for Certain Nuclear Decommissioning Funds

a. In General

b. Election to Treat Fund as Corporation

6. Subsequent Adjustments to ADSP

a. In General

b. Procedures for Making Adjustments

(1) Deemed Sale Tax Consequences Included in New Target's Return

(2) Loss Carryovers to New Target Taxable Years

(3) Loss Carrybacks to Old Target Taxable Years

F. Special Rules for Insurance Company Targets

1. Background: Assumption Reinsurance

2. The Final Regulations

a. Assumption Reinsurance Principles

b. Computing ADSP and AGUB

c. Allocating ADSP and AGUB

d. Consequences to Old Target and New Target

(1) In General

(2) Reserve Increases

(3) Effect of § 338 Election on Old Target's § 846(e) Election

(4) Effect of § 338 Election on Old Target's Capitalization Amounts Under § 848

(5) Section 197 Treatment of Rights Under Insurance Contracts

(6) Policyholders Surplus Account

(7) Section 847 Special Estimated Tax Payments

IV. Effects of a § 338(g) Election on New Target

A. In General

1. New Target Treated as New Corporation Under Subtitle A of the Code

2. New Target Treated as Continuation of Old Target Under Rest of Code

3. Special S Corporation Considerations

B. Adjusted Grossed-Up Basis

1. In General

2. Determination of Adjusted Grossed-Up Basis

a. Grossed-Up Basis in Recently Purchased Target Stock

b. Basis in Nonrecently Purchased Target Stock

(1) Effect of Gain Recognition Election

(2) Basis Amount

(3) Miscellaneous Gain Recognition Election Rules

c. Liabilities of New Target

(1) In General

(2) Time and Amount of Liabilities

(3) Contingent Liabilities

d. IRS Adjustments to AGUB

e. The AGUB Formula

C. Allocation of AGUB Among New Target's Assets

1. In General

2. Other Considerations in Allocating AGUB

a. Fair Market Value Limitation

b. Limitations Arising Under General Tax Principles

c. Effects of Nonrecently Purchased Stock on AGUB Allocations

d. New Target's Sale of Assets Subject to a Liability

3. Examples of AGUB and ADSP Allocations

a. Allocation Without Nonrecently Purchased Stock

b. Allocation with Nonrecently Purchased Stock

D. Subsequent Adjustments to AGUB

1. In General

2. Disposition or Depreciation of Assets

3. Redetermining and Reallocating AGUB and ADSP

V. The § 338(h)(10) Election

Introductory Material

A. In General

B. Planning Considerations: Whether to Make a § 338(h)(10) Election

1. Nontax Motivations for Stock Purchase

2. Seller's Perspective

a. “Outside” and “Inside” Basis

b. Net Operating Losses

c. S Corporation Shareholders

3. Purchaser's Perspective

4. Other Considerations

5. Price

C. Eligibility to Make a § 338(h)(10) Election

1. Consolidated Target

2. Affiliated Target

3. S Corporation Target

4. Ineligible Targets

D. Effect of § 338(h)(10) Election on Old Target

1. Transaction Model

a. In General

b. Consistency of Deemed and Actual Asset Sale

2. Deemed Asset Sale

a. In General

b. ADSP for Old Target

c. Reporting Gain or Loss on Old Target's Deemed Asset Sale

d. Continuation of S Corporation and QSub Status

e. Tiered Targets

3. Deemed Liquidation of Old Target

E. Effect of § 338(h)(10) Election on the Seller or Sellers

1. Deemed Sale of Target Assets

a. Selling Consolidated Group

(1) In General

(2) Mandatory Filing of Consolidated Returns

b. Selling Affiliate Liability

c. S Corporation Shareholders

2. Deemed Liquidation of Old Target

a. In General

b. Section 332 Liquidation

(1) In General

(2) Retained Assets

(3) Partial Liquidation

(4) Consolidated Return Consequences - Deferred Intercompany Transactions

c. Section 331 Liquidation

3. Gain or Loss on Stock Sale Ignored

4. Retained Target Stock

5. “Minority Shareholder”: Gain Recognition and Retained Target Stock

6. Using a New Corporation as Target for Unincorporated Assets

7. IPO Using § 338(h)(10)

8. Forward Merger Alternative

9. Availability of the Installment Method

F. Purchasing Corporation: Automatic Gain Recognition Election

G. New Target

1. AGUB for New Target

2. Transferee Liability

VI. The Consistency Rules

A. Introduction and Background

1. Summary

2. Reasons for Changes to Consistency Rules

a. Legislative History of § 338

b. General Utilities Repeal

c. Effect of General Utilities Repeal on Consistency Rules

B. Consistency Rules Generally

1. Asset Consistency

2. Stock Consistency

C. Carryover Basis Rule

1. In General

2. Exceptions

a. Section 338 Election for Target

b. Disposition of Tainted Asset

c. Regulatory Exceptions

3. Mitigation

D. Asset Consistency

1. In General

2. Tainted Asset Acquisitions

a. Consolidated Groups

(1) In General

(2) Lower Tier Target Affiliates

b. Non-Consolidated Groups

E. Stock Consistency

1. Section 338(h)(10) Transactions

2. CFC Stock and Lower Tier Target Affiliates

F. Controlled Foreign Corporations

1. Sales of Assets by a CFC That Generate Subpart F Income

2. Sale of Stock of CFC Target Affiliate

3. CFC Asset Sales Combined with Actual and Deemed Dividends

4. Section 245 Dividends from CFC Target

5. Wholly Foreign Acquisitions

G. Anti-Avoidance Rules

1. Indirect Asset Acquisitions

2. Other Anti-Avoidance Rules

a. Time Periods Extended

b. Conduits

c. Predecessors and Successors

VII. International Aspects of § 338

A. Background

B. Summary of Application of the Consistency Rules to Foreign Affiliates of Domestic Targets

C. General Principles: The § 1248 Factor

1. Section 1248 as an Anti-Abuse Provision

2. Section 1248 after the 1986 Act

3. “Enhanced” Earnings and Profits

a. Direct Purchase of a Foreign Corporation

b. Purchase of Holding Company

c. Amount of Enhanced Earnings

D. Sale of the Stock of a Foreign Corporation: Tax Consequences to a U.S. Seller

1. Character of Gain: § 1248

a. Pre-Acquisition Date Sales

(1) Staggered Stock Sales

(2) Target Loses CFC Status

b. Post-Acquisition Date Sales - Unsold Minority Stock: Carryover of Earnings and Profits

2. Foreign Tax Credits

a. In General

b. Deemed Paid Foreign Tax Credit

c. Source of Gain

d. Foreign Tax Credit Limitation

(1) In General

(2) Look-Through Rules for Dividends

(3) Foreign Tax Credit Limitation Basket for Foreign Corporation Stock Gain

(4) Effect of Enhanced Earnings and Profits on General Limitation Income

e. Section 338(h)(16)

(1) Operation of § 338(h)(16) to Cap General Limitation Income

(2) Operation of § 338(h)(16) When Domestic Target Has a Foreign Subsidiary

(3) Effect of § 338(h)(16) on Deemed Sale Earnings

(4) Operation of § 338(h)(16) When the Deemed Asset Sale Generates Subpart F Income

(5) Operation of § 338(h)(16) When Deemed Sale Subpart F Income Results in Loss on CFC Stock

(6) Section 338(h)(16) and the OFL Rules.

(7) Operation of § 338(h)(16) to Keep a Foreign Target's Taxable Year Open for Source and Foreign Tax Credit Limitation Purposes?

f. Allocation of Year-of-Sale Foreign Taxes

3. Foreign Target-Level Taxation, Subpart F, and Other Anti-Deferral Consequences

a. Foreign Target-Level Taxation

b. Deemed Sale Gains and Anti-Deferral Rules

c. Subpart F Income Is Taxable to the Seller

d. Impact of Subpart F Inclusion

e. Problems with a Second Tier CFC

(1) Double Taxation Problem

(2) Regulations’ Approach

(3) The 1997 Act

4. Effect of § 338 Election on § 936 Corporations

5. Section 338(h)(10): Additional Seller Considerations

E. Foreign Target: Tax Consequences to U.S. Purchaser

1. Earnings and Profits

a. Effect of § 338 Election

b. No § 338 Election

c. Planning Considerations

2. Asset Basis Step-Up

3. Subpart F

4. Section 338(h)(10): Additional Purchaser Considerations

F. Actual and Deemed Liquidations as an Alternative to a § 338 Election

G. Section 338 and Foreign Currency Issues

VIII. Miscellaneous Issues

A. New Target's Relationship to Old Target

1. In General

2. New Target Unrelated to Old Target

a. Depreciation

b. Methods and Taxable Years

c. Anti-Churning Rules of § 197

3. Exceptions to Subtitle A Unrelatedness

a. Employee Benefit Plans

b. Mitigation of Statute of Limitations

c. Other Provisions of Subtitle A

4. New Target Continuation of Old Target

a. Collection and Administration

b. Wage Withholding

c. Employer Identification Number

B. Interaction with Other Code Provisions

1. Section 269(b)

2. Sections 336(e) and 338(h)(10)(B)

3. Collapsible Corporations

4. Reorganization Provisions

5. Section 382 and Net Operating Losses

a. In General

b. Change Date Precedes Acquisition Date

6. Estimated Tax

7. Partnership Provisions

8. Insurance Companies

9. Section 1060

10. Nuclear Decommissioning Funds

11. Earnings Stripping

C. State and Local Tax Issues

IX. Mechanics of Elections

A. Election on Form 8023

B. Election Irrevocable

C. Making § 338 Elections

1. Electing Party or Parties

2. Contents of the Election

3. Timing

4. Filing the Election

5. Multiple Targets

D. Foreign Purchaser/Foreign Target

1. In General

2. CFC Purchaser/10% U.S. Shareholders File

3. Extension of Time for Election Until Election Has U.S. Tax Consequences

4. Foreign Targets; Schedule Requirement

5. U.S. Shareholders of Certain Foreign Targets; Notice Requirement

E. Gain Recognition Election

F. Signatures

G. Form 8883

1. In General

2. Timing and Mechanics

a. Old Target

b. New Target

3. Supplemental Form 8883

4. Multiple Targets

5. Contents of Form 8883

Working Papers

Table of Worksheets

Worksheet 1 Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases

Worksheet 2 Form 8883, Asset Allocation Statement Under Section 338

Worksheet 3 House Conference Committee Report on the Tax Equity and Fiscal Responsibility Act of 1982 (H.R. Conf. Rep. No. 760, 97th Cong., 2d Sess. (1982))

Worksheet 4 Senate Finance Committee Report on the Tax Equity and Fiscal Responsibility Act of 1982 (S. Rep. No. 494, 97th Cong., 2d Sess. (1982))

Worksheet 5 General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (H.R. 4961, 97th Cong.; P.L. 97-248) December 31, 1982

Worksheet 6 Conference Report on the Technical Corrections Act of 1982 (H.R. Conf. Rep. No. 986, 97th Cong., 2d Sess (1982))

Worksheet 7 House Ways and Means Committee Report on the Deficit Reduction Act of 1984 (H.R. Rep. No. 432, 98th Cong., 2d Sess. (1984))

Worksheet 8 General Explanation of the Tax Reform Act of 1986 (H.R. 3838, 99th Cong.; P.L. 99-514) May 4, 1987

Worksheet 9 Explanation of the Technical Corrections to the Tax Reform Act of 1984 and Other Recent Tax Legislation (Title XVIII of H.R. 3838, 99th Cong.; P.L. 99-514) May 4, 1987

Worksheet 10 House Conference Report on the Tax Reform Act of 1986 (H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. (1986))

Worksheet 11 House Report on Omnibus Budget Reconciliation Act of 1987 (H.R. Rep. No. 391, 100th Cong., 1st Sess., pt. 2 (1987))

Worksheet 12 Senate Report on Technical and Miscellaneous Revenue Act of 1988 (S. Rep. No. 445, 100th Cong., 2d Sess. (1988))

Worksheet 13 House Conference Report on Omnibus Budget Reconciliation Act of 1990 (H.R. Conf. Rep. No. 964, 101st Cong., 2d Seas. (1990))

Worksheet 14 T.D. 7855, 1982-2 C.B. 79, Preamble to Temporary Regulations (Extension of Time for Making § 338 Elections Under TEFRA)

Worksheet 15 T.D. 7942, 1984-1 C.B. 93, Preamble to Temporary Regulations (§ 338 Election Repeals Old § 334(b)(2))

Worksheet 16 T.D. 7975, 1984-2 C.B. 81, Preamble to Temporary Regulations (Changes to § 338 Election Made by TRA 84)

Worksheet 17 T.D. 8021, 1985-1 C.B. 96, Preamble to Temporary Regulations (Guidance on § 338 Election)

Worksheet 18 T.D. 8068, 1986-1 C.B. 165, Preamble to Temporary Regulations (Guidance on § 338 Elections; Extension of Time to Elect)

Worksheet 19 T.D. 8072, 1986-1 C.B. 111, Preamble to Temporary Regulations (§ 338 Election; Allocation and Subsequent Adjustments to Adjusted Grossed-Up Basis)

Worksheet 20 T.D. 8074, 1986-1 C.B. 126, Preamble to Temporary Regulations (International Aspects of § 338 Election)

Worksheet 21 T.D. 8088, 1986-1 C.B. 103, Preamble to Temporary Regulations (Statements to be Filed in § 338 Election Under § 338(g); Extension of Statute of Limitations)

Worksheet 22 T.D. 8092, 1986-2 C.B. 49, Preamble to Temporary Regulations (Allocation of Basis to New Target's Assets Under § 338 Election)

Worksheet 23 T.D. 8215, 1988-2 C.B. 305, Preamble to Temporary Regulations (Allocation of Consideration Among Assets Under § 1060)

Worksheet 24 T.D. 8339, 1991-1 C.B. 52, Preamble to Temporary Regulations (Determination of the Amount of Gain or Loss Recognized by Target Corporation on Deemed Sale of Assets Under § 338)

Worksheet 25 CO-111-90, 1992-1 C.B. 1000, Preamble to Notice of Proposed Rulemaking (Stock and Asset Consistency Rules)

Worksheet 26 T.D. 8515, 1994-1 C.B. 89, Preamble to Final and Temporary Regulations (Stock and Asset Consistency Rules)

Worksheet 27 T.D. 8516, 1994-1 C.B. 119, Preamble to Temporary Regulations (Stock and Asset Consistency Rules Under § 338 Applied to Controlled Foreign Corporations)

Worksheet 28 T.D. 8626, 1995-2 C.B. 34, Preamble to Final Regulations (Treatment of Transfer of Target Corporation Assets to Purchasing Corporation or Other Affiliated Group Member of Purchasing Corporation After Qualified Stock Purchase Where No § 338 Election Made)

Worksheet 29 T.D. 8711, Preamble to Final and Temporary Regulations, 62 Fed. Reg. 2267, 1/16/97 (Purchase Price Allocation for Taxable Asset Acquisitions and Deemed Asset Purchases Under § § 338 and 1060 and Treatment of Intangible Assets Under § 197)

Worksheet 30 T.D. 8710, Preamble to Final Regulations, 62 Fed. Reg. 3458, 1/23/97 (Stock and Asset Consistency Rules Under § 338 Applied to Controlled Foreign Corporations)

Worksheet 31 REG-107069-97, Preamble to Proposed Regulations, 64 Fed. Reg. 43461, 8/10/99 (Proposed Regulations Under § § 338 and 1060 Regarding Purchase Price Allocations)

Worksheet 32 T.D. 8858, Preamble to Temporary Regulations, 65 Fed. Reg. 1235, 1/7/00 (Temporary Regulations Under § § 338 and 1060 Regarding Purchase Price Allocations)

Worksheet 33 REG-118861-00, Preamble to Proposed Regulations, 67 Fed. Reg. 10640, 3/8/02 (Proposed Regulations Under § § 338 and 1060 Regarding Deemed Sale or Acquisition of Insurance Companies)

Worksheet 34 T.D. 8940, Preamble to Final Regulations, 66 Fed. Reg. 9925, 2/13/01 (Purchase Price Allocations in Deemed and Actual Asset Acquisitions)

Worksheet 35 T.D. 9071, Preamble to Final and Temporary Regulations, 68 Fed. Reg. 40766, 7/9/03 (Effect of Elections in Certain Multi-step Transactions)

Worksheet 36 T.D. 9158, Preamble to Final and Temporary Regulations, 69 Fed. Reg. 55740, 9/16/04 (Treatment of Certain Nuclear Decommissioning Funds for Purposes of Allocating Purchase Price in Certain Deemed and Actual Asset Acquisitions)

Worksheet 37 T.D. 9271, Preamble to Final Regulations, 71 Fed. Reg. 38074, 7/5/06 (Effect of Elections in Certain Multi-Step Transactions)

Bibliography

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Federal Statutes:

Federal Regulations:

Revenue Rulings and Procedures:

Notices:

Announcements:

Federal Cases:

State Law Materials:

California:

Illinois:

New York:

Joint Committee Explanations:

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Tax Services & Treatises:

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