On May 15, 2013, the Department of the Treasury issued final regulations regarding a new election now permitted under Section 336(e) of the Internal Revenue Code that allows sellers to elect to treat transactions structured as stock sales for corporate law purposes as asset sales for federal income tax purposes. This election can apply in certain circumstances where the parties are not eligible to make a similar election under Section 338(h)(10) of the Code. The election is now available for transactions occurring on or after May 15, 2013. Consequently, parties involved in transactions involving corporate entities will want to understand the possible availability and impact of the Section 336(e) election on any proposed transaction.
The Section 336(e) election is available to a seller that sells at least 80% of the stock of a corporation (measured by both voting rights and overall value) within a 12 month period. If the election is filed, the sold corporation is treated as selling its assets to a new corporation for an amount equal to the purchase price paid for the stock plus any assumed liabilities. The sold corporation is then treated as liquidating and distributing the sale proceeds to the selling shareholders. As a result, the gain (or loss) inherent in a corporation’s assets is triggered and the selling shareholders, depending upon the circumstances, may or may not incur additional gain or loss upon the deemed liquidating distribution. The tax results are similar to the results of a transaction involving a Section 338(h)(10) election. The purchaser is treated as acquiring the new corporation which has a full stepped-up basis in its assets equal to the deemed purchase price paid for the assets. If elections under both Section 338(h)(10) and Section 336(e) could apply to a transaction, the regime of Section 338(h)(10) is deemed to take precedence.
Both a corporate parent selling the stock of a corporate subsidiary out of a consolidated group and the shareholders of an S corporation selling the S corporation stock are eligible to make the Section 336(e) election. Significantly, and unlike a Section 338(h)(10) election, the purchaser need not be a corporate entity for the transaction to be eligible for the Section 336(e) election. Consequently, the Section 336(e) election may be most useful in circumstances where individual or partnership (including limited liability company) acquirers are seeking to acquire the stock of a corporate target while still enjoying the benefit of a step-up in the tax basis in the target corporation’s assets equal to the purchase price paid for the stock.
There are several aspects of the Section 336(e) election that could be significant in a transaction and should be noted:
The Section 336(e) election is made unilaterally by the sellers; consequently, for purchasers seeking to take advantage of (or avoid) an election, the acquisition agreement will need to contractually commit the sellers to the desired course of action.
All shareholders of an S corporation target must consent to the Section 336(e) election (and gain is triggered to all shareholders upon the election) even if all shareholders are not participating in the sale.
The acquired corporation will be treated as a new corporate taxpayer in the hands of the purchasers and, if eligible to be treated as an S corporation, a new S corporation election will need to be filed on its behalf.
Although treated as a new corporate taxpayer, the acquired corporation will remain liable as a matter of law for all pre-closing corporate level taxes; responsibility for such taxes should be clearly addressed in the acquisition agreement.
A Section 336(e) election should be made on Form 8883 (until a new form is developed) and filed in connection with the tax returns for the pre- and post-closing short-years for the acquired corporation for the year of acquisition.
Although of fairly narrow application, the new Section 336(e) election is likely to be advantageous in particular circumstances and should be carefully considered by taxpayers and their advisors in connection with the planning for purchases and sales of corporate entities.