Tax Advantage - Section 338(h)(10) can help S corp buyers and sellers

If you’re planning to sell a business arranged as
a subchapter S corporation, a provision of the
federal tax code can make you a more
appealing target for buyers. Even better, it
could boost your sale price.
Why buyers like the code
S corporations don’t pay income taxes. Instead, the
company’s income or losses are
distributed through its
shareholders, who in turn report
income or losses on their
individual income tax returns. This
fact can potentially complicate the
sale of an S corporation.
Internal Revenue Code Section
338(h)(10), however, enables a
stock sale of an S corporation to
be taxed as if the transaction were
an asset sale. Asset sales offer
several advantages. For one, the buyer can take a
“stepped-up” tax basis, which means it can
significantly raise the stated value of the seller’s
assets. Greater asset value, in turn, enables a
buyer to claim more depreciation on its to-beacquired
assets and, therefore, take a larger,
current tax deduction.
What’s in it for sellers
This advantageous tax situation puts selling S
corporations in an excellent negotiating position.
Buyers must obtain the approval of the selling
company’s shareholders to structure a deal that
includes a 338(h)(10) election. And buyers typically
are willing to agree to a higher purchase price in
exchange for shareholder cooperation.
In a 2005 study analyzing S corporations, Merle
Erickson, an accounting professor at the University
of Chicago’s Booth School of Business, and Shiingwu
Wang, a professor at the University of Southern California’s Marshall School of Business, estimated
that the tax benefits of S corporation acquisitions
total, on average, approximately 12% to 17% of the
deal’s value.
For example, when Coca-Cola Enterprises
acquired the S corporation Herb Coca-Cola Inc. in
2001, it paid Herb’s shareholders an extra $100
million to approve the 338(h)(10) election.
Coca Cola reportedly valued the tax
benefits of the election at $145 million,
thus paying Herb shareholders 70% of
the total tax benefits.
Despite these kinds of benefits, many S
corporation sellers are unaware of or illinformed
about the tax code provision.
Unfortunately, sometimes buyers use
seller ignorance to take the deduction
without offering a higher acquisition price
in return.
Know your advantage
Realizing the tax advantages of Section 338(h)(10)
is a complex process. So it’s essential to work with
experienced advisors who are knowledgeable
about tax issues. They can help you determine if
your business is eligible and ensure you get an
equitable share of any tax benefits a buyer derives
from the acquisition.