Election to Treat the Purchase of Stock of an S Corporation as the Purchase of the S Corporation’s Assets

August 1, 2014

In determining how to structure the purchase of an S corporation, the purchasing corporation will prefer to purchase the assets of the S corporation to obtain a new cost basis in the purchased assets. A stock purchase results in a cost basis in the purchased stock but not in a step‑up in the basis of the assets of the S corporation. However, the purchasing corporation may be required to purchase the stock of the S corporation for non‑tax reasons, e.g., the inability to transfer certain licenses of the S corporation to the purchasing corporation.

Section 338 of the Internal Revenue Code permits a purchasing corporation making a “qualified stock purchase” of a target corporation to elect to have the transaction treated as the purchase of the assets of the target corporation, and, thus, to obtain a new cost basis in the purchased assets. Generally, a “qualified stock purchase” is the purchase of at least 80% of the value of the target corporation’s outstanding stock by another corporation.

If the target corporation is an S corporation, the target S corporation’s shareholders and the purchasing corporation can agree to make an election under Internal Revenue Code Section 338(h)(10) and Regulation Section 1.338(h)(10)-1(c). When this election is made the sale of stock by the selling shareholders is ignored. Instead, the S corporation is deemed to have sold its assets to the purchasing corporation for their fair market value based on the purchase price of the stock and to liquidate. Any gain or loss on the deemed sale flows through to the S corporation’s shareholders.

If the purchasing corporation is also an S corporation, the target corporation will be a qualified S corporation subsidiary of the purchasing S corporation, and, for tax purposes, will be deemed to be liquidated into the purchasing S corporation.

If you have any questions about how the information in this article may affect you or your business, please contact Bob Schwab at rschwab@stroudlaw.com or (608) 257‑2281 or your Stroud attorney. 

DISCLAIMER: The information in this article is provided for general informational purposes only, is not necessarily updated to account for changes in the law, and should not be considered tax or legal advice. This article is not intended to create, nor does the receipt of it constitute, an attorney‑client relationship. You should consult with your own legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.