Final Section 336(e) Regulations Allow Step-Up in Asset Tax Basis in Certain Stock Acquisitions
Final regulations were issued last month under IRC Section 336(e). These regulations present beneficial planning opportunities in certain circumstances.
For qualifying transactions occurring on or after May 15, 2013, Section 336(e) allows certain taxpayers to elect to treat the sale, exchange or distribution of corporate stock as an asset sale, much like a Section 338(h)(10) election. An asset sale can be of great benefit to the purchaser of the stock, since the basis of the target corporation’s assets would be stepped up to their fair market value.
To qualify for the Section 336(e) election, the following requirements must be met:
The selling shareholder or shareholders must be a domestic corporation, a consolidated group of corporations, or an S corporation shareholder or shareholders.
The selling shareholder or shareholders must own at least 80% of the total voting power and value of the target corporation’s stock.
Within a 12-month period, the selling shareholder or shareholders must sell, exchange or distribute 80% of the total value and 80% of the voting power of the target stock.
Although the rules of Section 338(h)(10) are generally followed in connection with a Section 336(e) election, there are a few important differences between the two elections:
Section 336(e) does not require the acquirer of the stock to be a corporation. This is probably the most significant difference; and, to take advantage of this rule, purchasers other than corporations may wish to convert the target without tax cost to a pass-through entity (e.g., LLC) after the purchase.
Section 336(e) does not require a single purchasing corporation to acquire the target stock. Instead, multiple purchasers—individuals, pass-through entities and corporations—can be involved.
The Section 336(e) election is unilaterally made by the selling shareholders attaching a statement to their Federal tax return for the year of the acquisition. Purchasers should use the acquisition agreement to make sure the sellers implement the anticipated tax strategy
Section 336(e) offers some nice tax planning opportunities, by allowing a step up in tax basis in the target’s assets where a Section 338(h)(10) election is not allowed.
Example: An S corporation with two shareholders wishes to sell all of its stock to several buyers, all of which are either individuals or pass-through entities with individual owners. A straight stock purchase would not increase the basis of the assets held inside the S corporation, and an LLC or other entity buyer would terminate the pass-through tax treatment of the S corporation status of the target. A Section 338(h)(10) election is not available since the purchaser is not a single corporation. However, a Section 336(e) election may be available, whereby the purchase of the stock would be treated as a purchase of the corporation’s assets (purchased by a “new” corporation owned by the purchasers). The purchasers could then convert the purchased corporation (the “new” corporation with the stepped-up assets basis) into an LLC, without tax, thereby continuing the business in a pass-through entity (single level of tax) with a fully stepped-up tax asset basis.