Section 338(h)(10) Election Analysis: How It Works, Who It Fits, and the Catch

How the election works

A corporate buyer that acquires at least 80% of a target's stock (by vote and value) within 12 months makes a "qualified stock purchase." If the target is an S corporation or a member of a selling consolidated group, the buyer and the sellers can jointly elect under Section 338(h)(10). For tax purposes:

1. The old target is treated as selling all of its assets to a new target at the deal price (plus liabilities) in a single transaction.
2. The old target is treated as liquidating, distributing the proceeds to its shareholders.
3. The new target takes a fresh basis in the assets, allocated among the seven Section 1060 classes.

The election is made on Form 8023, signed by the buyer and by the S corporation shareholders (including any who do not sell), no later than the 15th day of the 9th month beginning after the month of the acquisition date. It is irrevocable. Both old and new target file Form 8883 to report the allocation.

Section 336(e) and the F reorganization alternative

Section 336(e) reaches deals 338(h)(10) cannot: the buyer does not have to be a corporation, and the 80% can be sold to several unrelated buyers within 12 months (a "qualified stock disposition"). The sellers and target sign a written, binding election agreement and attach an election statement to the return; for an S corporation target, all S shareholders must sign (Treas. Reg. 1.336-2(h)).

An F reorganization is the other common route. The S corporation owners form a new holding company, the old company becomes a qualified subchapter S subsidiary and converts to an LLC, and the buyer purchases LLC interests: an actual asset purchase for tax, with no reliance on the target's S election having been valid (see Rev. Rul. 2008-18). Buyers often prefer it because an invalid S election would make a 338(h)(10) or 336(e) election fail.

What the seller gives up

In a plain stock sale, an S corporation owner usually has one long-term capital gain on the stock. In a deemed asset sale, gain is computed asset by asset and flows through the S corporation's K-1:

• Equipment depreciation comes back as Section 1245 ordinary income, recognized in the year of sale even with a note (IRC 453(i)).
• Inventory and cash-basis receivables produce ordinary income.
• A former C corporation can owe the Section 1374 built-in gains tax if the recognition period has not run.
• State tax can change: a deemed asset sale may be sourced to the states where the company operates instead of the owner's home state.
• Differences between stock basis and the corporation's asset basis create a capital gain or loss on the deemed liquidation.

The buyer, meanwhile, gets basis it can depreciate (equipment can take 100% bonus depreciation for property acquired after January 19, 2025) and goodwill it can amortize over 15 years. The usual fix is a gross-up: the buyer adds to the price enough to cover the seller's extra tax.

Who it fits, and who it does not

• Fits: S corporation sellers with mostly goodwill and little depreciated equipment, where the extra tax is small.
• Fits: subsidiaries sold by a consolidated group, where the group would pay corporate tax either way.
• Fits: deals where the buyer values the step-up and will pay a fair gross-up.
• Does not fit: equipment-heavy companies with large recapture and no gross-up.
• Does not fit: former C corporations still inside the built-in gains recognition period, unless priced in.
• Not available: stand-alone C corporations owned by individuals; the deemed sale would be taxed at the corporate level and again to shareholders, so buyers rarely ask.

Worked example

Assumptions (engine, 2026 federal rules, married filing jointly, Texas, active owner so no NIIT, $150,000 of other income): an S corporation sells for $10,000,000. The owner's stock basis and the corporation's asset basis are both $2,000,000. In a deemed asset sale, $1,500,000 of the gain is Section 1245 recapture on fully depreciated equipment and the rest is goodwill. No built-in gains tax applies.

The election costs the seller $206,546 more federal tax on the same price. A gross-up would need to cover that plus the tax on the gross-up itself. The buyer, in exchange, gets $1,500,000 of equipment basis it may be able to expense and $6,500,000 of goodwill to amortize over 15 years. Numbers are illustrative engine output.

IRS stance and audit risk

These elections are written into the Code and regulations; they are ordinary M&A practice, not listed transactions. Audit and failure risks are technical: a missed Form 8023 deadline, a shareholder who did not sign, a target whose S election was invalid (which turns the deal into a C corporation sale), inconsistent Form 8883 allocations between old and new target, and allocations to equipment or goodwill that do not match values. Late-election relief may be available in some cases, but it is not something to count on.

Costs and fees

• The seller's added tax on recapture, ordinary items and any built-in gains tax.
• Negotiating and modeling a gross-up, including tax on the gross-up.
• Valuation support for the asset allocation.
• S corporation diligence on election validity, and restructuring costs for an F reorganization if used.

How it compares with a Section 453 installment sale

The election and an installment sale can be combined. If part of the price is paid on a note, the regulations let the deemed asset sale use the installment method (Treas. Reg. 1.338(h)(10)-1(d)(8)), so capital gain on goodwill can be spread over the payment years. Recapture still lands in year one. In a stock sale without an election, the owner's stock gain can also be reported on the installment method.

Protect any note the way you would any seller financing: a down payment, a security interest in the company's assets or a pledge of the stock, a personal guarantee from the buyer's owners where available, and default and acceleration terms. See purchase price allocation for the asset classes and personal goodwill for C corporation alternatives.

How Hans helps

The $5,000 Big Sale Tax Analysis computes the seller's tax under a stock sale, a 338(h)(10) or 336(e) deemed asset sale, and an installment schedule, so you know the gross-up you need before you agree to the election. Start with the one-year vs spread estimate or see the analysis.

Frequently asked questions