22 Dec Section 338(h)(10) Election – Both a Stock and an Asset Purchase (Part 3 of 3)
- As stated in yesterday’s posting, a C Corp cannot own an S Corp. But if Purchaser (P) is an S Corp and acquires 100% of Target’s (T’s) stock, it can make a Qualified Subchapter S Subsidiary (QSub) Election. The QSub Election is done by filing IRS Form 8869. Both P and T then become pass through entities thereby eliminating tax at the corporate level.
- Because of potential ordinary income recapture in a deemed asset purchase, T’s S Corp sellers – who agree to the H-10 Election – are likely to pay more taxes than they would have paid in a stock purchase (for tax purposes). The parties will often negotiate a higher price to compensate for this additional tax cost borne by the seller.
- If T was not an S Corp for its entire existence, there may be a recapture of a built-in gain (BIG) upon the deemed asset purchase. The definitive purchase & sale agreement should specifically identify the party (P or T) responsible for paying the BIG tax liability.
- The treatment of the H-10 election for state income tax purposes is less certain because most states do not have statutes or regulations addressing this issue. Appropriate steps should be taken by P and T to determine their respective state income tax treatment.
- Lastly. The H-10 Election is complex. Parties to the transaction should seek legal and tax advice from professionals well versed in the H-10 Election.
Darrell Arne began his professional career in public accounting in 1970. In 1983, Darrell formed his own CPA practice, with emphasis on business valuation; by 1992, he had earned the Accredited Senior Appraiser (ASA) designation in business valuation. He then earned the Certified Business Intermediary (CBI) designation in 1995, and Certified Merger & Acquisition Advisor (CM&AA) designation in 2008.
He discontinued practicing in public accounting in 1994 when he formed Arne & Co., specializing in exit strategy planning for business owners, business valuations, business acquisitions & sales, business dispute mediation, part-time CFO services, and developer of business training seminars.