What Is a 338(h)(10) Election and Should I Consider It?

When buying or selling a business structured as an S corporation or a subsidiary in a consolidated group, one of the most overlooked but impactful – but often misunderstood – tax planning tools is the Section 338(h)(10) election. This joint election can dramatically alter the tax consequences of a transaction, often creating a win-win for buyers and sellers – if used correctly.

In transactions involving stock sales of corporations—especially S corporations or subsidiaries in consolidated groups—this election allows buyers and sellers to treat a stock sale as an asset sale for tax purposes. This creates opportunities for favorable depreciation and amortization, but it also introduces complexity and potential tax exposure.

Understanding when and why this election matters can help avoid costly tax consequences and uncover planning advantages that might otherwise go unnoticed.

What Is a Section 338(h)(10) Election?

A 338(h)(10) election is a joint tax election that allows a stock sale to be treated as a deemed asset sale for federal income tax purposes.

Normally, when a buyer acquires a company’s stock, they step into the shoes of the seller without resetting the tax basis of the underlying assets. However, when this election is made:

The buyer still acquires the stock, preserving the legal structure of the entity.
But for tax purposes, the transaction is treated as if the target sold all its assets at fair market value and then liquidated.

This dual treatment offers a hybrid structure—legal continuity with tax flexibility.

When Can a 338(h)(10) Election Be Made?

This election applies only in specific situations:

The target must be a domestic corporation.
The transaction must be a qualified stock purchase (QSP), meaning the buyer acquires at least 80% of the vote and value of the stock within a 12-month period.
The target must be either an S corporation or a member of a consolidated group.

Both buyer and seller must agree to the election by filing Form 8023 with the IRS by the due date, generally within 8.5 months after the close of the acquisition year.

Why Would a Buyer Want a 338(h)(10) Election?

The biggest benefit for buyers is the ability to “step up” the tax basis of the acquired assets.

When the deal is treated as an asset sale for tax purposes:

Buyers receive a new basis in the assets, aligned with fair market value.
This increases depreciation and amortization deductions.
Over time, those deductions can significantly reduce taxable income.

For example, goodwill and certain intangibles can be amortized over 15 years, which improves after-tax cash flow.

Why Would a Seller Agree to This Election?

Sellers might agree if the overall tax outcome is neutral or beneficial, or the Buyer increases the purchase price to compensate the Seller for any increased tax burden.

For S corporations, the deemed asset sale result is passed through to shareholders, potentially requiring them to:

Recognize some of the gain on sale as ordinary income, for example on depreciation recapture.
Often Buyers will agree to “gross up” the purchase price for the Selling shareholders’ additional tax caused by the difference between the deemed asset sale and a stock sale.
Buyers often increase the purchase price—or structure an earnout or installment plan—to offset the seller’s higher tax cost, especially if ordinary income from depreciation recapture is significant.

In consolidated groups, parent companies may accept the election if they have net operating losses, tax credits, or other tax attributes that can offset the gain on the deemed sale.

What Are the Downsides of a 338(h)(10) Election?

While powerful, the election isn’t always favorable.

Key drawbacks include:

Higher tax for sellers: If the seller recognizes significant gain, especially ordinary income, their tax bill could increase.
Complex tax compliance: Additional tax filings and calculations are required, including Form 8883 to allocate purchase price among assets.
State tax issues: Not all states conform to federal treatment, leading to mismatches.

The election creates a taxable asset sale, which may trigger sales tax, transfer taxes, or other regulatory consequences depending on jurisdiction.

Should You Consider a 338(h)(10) Election?

You should consider this election if you’re buying a business and want to increase tax deductions through asset basis step-up, and the seller is willing to accommodate the tax consequences.

This election can unlock long-term tax savings—but only when:

The deal structure qualifies under IRS rules.
Both parties agree to the election.
The benefits to the buyer outweigh the costs to the seller.
The compliance burden is worth the tax outcome.

Planning tip: Because the 338(h)(10) election must be made jointly and filed on a strict timeline, it’s critical to raise the issue early—ideally during LOI negotiations. Waiting until closing or after can limit your ability to make the election or negotiate the purchase price effectively.

Alternative to Consider: In recent years, many M&A tax experts opt for a tax-deferred F reorganization instead of a 338(h)(10) election when the target is an S corporation and the buyer is not a C corporation. An F reorg is worth evaluating alongside a 338(h)(10) election, especially in private equity deals.

What Happens If You Don’t Make the Election?

Without a 338(h)(10) election, the buyer inherits the target’s existing tax basis in assets.

That means:

No step-up in basis.
Lower depreciation deductions.
Potential exposure to unknown tax liabilities embedded in the old entity.

While simpler, this approach can lead to higher long-term tax costs for the buyer.

How Is the Purchase Price Allocated in a 338(h)(10) Election?

The IRS requires allocation of the total purchase price across asset classes using the Residual Method under IRC Section 1060.

Common categories include:

Cash and equivalents
Accounts receivable
Inventory
Tangible property (Equipment, Buildings)
Intangibles like customer lists and goodwill

Proper allocation affects how quickly the buyer can depreciate or amortize assets, and misallocation can trigger IRS scrutiny.

FAQs

Q. What types of businesses most often use the 338(h)(10) election?

It’s most common in the acquisition of S corporations and subsidiaries of consolidated groups, especially where buyers want a stepped-up basis.

Q. Can a 338(h)(10) election be revoked after filing?

No. Once filed and accepted, the election is irrevocable.

Q. Is a 338(h)(10) election available for partnerships or LLCs?

No. It’s strictly available for corporations, not for partnerships or LLCs taxed as partnerships.

Q. How long does it take to prepare and file the required forms?

Generally, several weeks—buyers and sellers must collaborate on calculations and file within strict IRS deadlines.

Q. Do all states follow federal 338(h)(10) treatment?

No. Some states do not conform, which could create conflicting state tax obligations.

Q. Does the election affect employment agreements or contracts?

Not directly. Since the legal entity remains intact, most agreements stay in place—but some contracts may have change-of-control clauses.

Q. Is Form 8023 the only requirement?

No. Form 8883 must also be filed to report the purchase price allocation.

Q. What happens if the buyer fails to file Form 8883?

The IRS may disallow the stepped-up basis, leading to loss of deductions and penalties.

Can this election apply in private equity acquisitions?

Yes, especially when acquiring portfolio companies organized as S corporations.

Q. Is a 338(g) election the same as 338(h)(10)?

No. A 338(g) election is made unilaterally by a buyer and does not require seller consent—but it applies primarily to C corporations.

Q. Can the purchase price allocation be disputed by the IRS?

Yes. The IRS can challenge allocations it deems unreasonable, especially if they disproportionately favor goodwill over ordinary-income-producing assets.