Choosing the Right Transaction Structure for S Corporation Acquisitions

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One unique aspect of acquisitions involving S Corporation targets is the availability of a Section 338(h)(10) election under the Internal Revenue Code. A 338(h)(10) election allows an acquirer of S Corporation shares to treat the transaction as the acquisition of assets, for federal income tax reporting purposes. This gives the acquirer a “step-up in basis” with respect to the acquired assets, and the corresponding ability to amortize certain assets (e.g., goodwill) over 15 years for tax purposes. The acquirer receives an economic benefit equal to the present value of the future tax deductions.

But what is the economic advantage to the selling stockholders? On the surface, one might say there is actually a disadvantage. By agreeing to the 338(h)(10) election, the selling stockholders forego the favorable long-term capital gain tax rate that would apply in a stock sale and, as a result, incur a higher tax burden from the deal. This being the case, informed sellers may try to negotiate a higher price to protect against the higher level of tax associated with asset sale treatment (under the right circumstances acquirers will be open to this negotiation).

It is important to note that the 338(h)(10) election cannot be made unilaterally by the acquiring company; 100% of the selling shareholders must consent to the election. As such, informed S Corporation sellers may attempt to “share” in the buyer’s post-closing tax benefits by seeking an incremental price increase.

Section 338(h)(10) elections are but one of many complex issues that buyers and sellers encounter in S Corporation M&A transactions. Whether viewing the deal from the buy-side or the sell-side, all available information should be considered before the transaction closes.

Aronson LLC’s transaction advisory experts provide custom-tailored financial, accounting and tax due diligence services. Whether providing comprehensive transaction support or supplementing the deal team’s capabilities in a limited way, Aronson’s professionals deliver practical M&A guidance designed to identify risks and enhance deal value. To learn more, contact Bill Foote at 301.231.6299.

About Bill Foote

Bill Foote has written 1 post in this blog.

Bill Foote is a partner in Aronson LLC’s Forensic & Valuation Services practice. He also leads Aronson’s Transaction Advisory Services practice. Bill has 18 years of consulting and assurance experience serving clients in a variety of industries, including government contracting, technology, construction, real estate, and professional services. Bill’s consulting background includes projects such as: lost profits and lost earnings damages calculations; post-acquisition disputes; fraud investigations; buy-side financial/accounting due diligence; valuations for estate and gift tax compliance; valuations for stock option plans; purchase price allocations and goodwill impairment testing; valuations for S Corporation conversions; and valuations for disputes.

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