A Section 338 election is a federal tax choice that lets a corporate buyer treat its purchase of a target company’s stock as if it had bought the target’s assets instead. The stock deal still happens legally, but for tax purposes the target is deemed to sell all of its assets to a new version of itself at fair market value. That resets the tax basis of every asset, which gives the buyer larger depreciation and amortization deductions in later years. The cost is immediate: the deemed asset sale triggers a current tax bill on any built-in gain. The election only makes sense when the present value of the future deductions is worth more than that upfront tax.
Who Can Make the Election
The election is not available on every stock deal. The buyer has to first complete what the code calls a Qualified Stock Purchase, or QSP. A QSP means one corporation buys at least 80 percent of the target’s total voting power and at least 80 percent of the total value of the target’s stock within a 12-month window.1Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions The 80 percent threshold traces back to the affiliated-group ownership test in Section 1504(a)(2).2Office of the Law Revision Counsel. 26 USC 1504 – Definitions
The 12-month acquisition period begins on the date the buyer first acquires stock that counts toward the QSP. Every share contributing to the 80 percent has to be picked up inside that window.1Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
Not every share counts. Nonvoting preferred stock that is limited to a fixed dividend, doesn’t participate in corporate growth, has redemption and liquidation rights capped near the issue price, and isn’t convertible is excluded from the calculation entirely.2Office of the Law Revision Counsel. 26 USC 1504 – Definitions The stock also has to be acquired by “purchase” as the statute defines it. Shares picked up in tax-free Section 351 contributions, tax-free reorganizations, or transactions with related parties whose ownership is attributed to the buyer under constructive ownership rules don’t qualify.3Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
Completing a QSP is the prerequisite. It doesn’t happen automatically. The buyer still has to affirmatively opt in.
Two Versions: 338(g) and 338(h)(10)
Section 338 comes in two flavors, and the choice controls who pays tax on the deemed sale.
The 338(g) Election
A 338(g) election is available for any QSP, regardless of how the seller is structured. The problem is double taxation. The old target recognizes gain on the deemed asset sale and pays corporate tax on it. Separately, the selling shareholders recognize gain on the actual stock sale and pay tax on that. Two levels of tax on the same economic transaction make 338(g) a bad deal in most domestic acquisitions, unless the target has enough net operating losses or built-in losses to soak up the deemed-sale gain.
Where 338(g) is commonly useful is in cross-border deals. When a U.S. corporation buys stock in a foreign subsidiary, the deemed-sale gain recognized by the foreign target may not be subject to U.S. corporate tax at all, or the consequences may be more manageable under the international rules. That eliminates or sharply reduces the double-tax problem, which is why 338(g) elections show up far more often in acquisitions of controlled foreign corporations than in purely domestic deals.
The 338(h)(10) Election
The 338(h)(10) election solves the double-tax problem but is only available in specific situations. The target has to be a member of a consolidated group, an affiliated group filing separate returns, or an S corporation.3Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
Under (h)(10), the stock sale is disregarded for tax purposes. The selling group is treated as if the target sold its assets and then liquidated. The seller recognizes gain or loss only on the deemed asset sale; the gain or loss that would have been triggered by the actual stock sale is ignored.3Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions For a consolidated group target, that gain flows up to the parent’s consolidated return. For an S corporation target, it passes through to the individual shareholders.
The result is a single level of tax. The buyer gets the stepped-up basis it wants, and the seller avoids a second layer of tax on the stock sale. Both sides benefit, which is why the (h)(10) election typically shows up as a higher purchase price. The buyer will pay more because it is getting larger future deductions; the seller demands more because it is consenting to asset-sale treatment that may produce a different character of gain than a straight stock sale would.
Procedure matters here too. A (h)(10) election requires both buyer and seller to jointly sign the election form, so neither side can make it unilaterally. That forces the tax treatment into the deal negotiation rather than leaving it as something the buyer decides after closing.
What Happens Tax-Wise: The Deemed Sale and the Basis Step-Up
The mechanics of a Section 338 election are a legal fiction. The tax code treats the “old target” corporation as having sold every one of its assets to a brand-new entity, the “new target,” at the close of the acquisition date. Nothing actually changes hands. But the old target must recognize gain or loss on that deemed sale as if it had.3Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
The price assigned to that fictional sale depends on which election is made. A 338(g) uses the Aggregate Deemed Sales Price (ADSP), which roughly equals the grossed-up amount the buyer paid for the stock plus the target’s liabilities.4eCFR. 26 CFR 1.338-4 – Aggregate Deemed Sale Price A 338(h)(10) uses the Modified Aggregate Deemed Sales Price (MADSP), which adjusts for the tax consequences of the stock sale.
Gain is calculated asset by asset, and character matters. Inventory produces ordinary income. Long-held capital assets produce capital gain. Depreciable property runs through the recapture rules under Sections 1245 and 1250, which recharacterize some or all of the gain as ordinary income to the extent the seller previously claimed depreciation.5Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets With the federal corporate rate at 21 percent, a target with heavily depreciated assets and significant built-in gains can face a substantial bill on the deemed sale.
On the other side of the fiction, the new target is deemed to have purchased all of those assets at a total price equal to the Adjusted Grossed-Up Basis (AGUB). AGUB starts with the grossed-up basis of the buyer’s recently purchased stock, adds the buyer’s basis in any stock it held before the QSP, and adds the target’s liabilities, including any tax liability triggered by the deemed sale itself.6eCFR. 26 CFR 1.338-5 – Adjusted Grossed-Up Basis
That total AGUB is then allocated across the target’s individual assets using the residual method, which fills seven asset classes in sequence at fair market value.7eCFR. 26 CFR 1.338-6 – Allocation of ADSP and AGUB Among Target Assets Cash goes first, then actively traded securities, then debt instruments and receivables, then inventory, then other tangible property like equipment and buildings, then Section 197 intangibles other than goodwill, and finally goodwill and going concern value in the last class.
The last class is where most of the action is. When a buyer pays a premium over the fair market value of identifiable assets, the excess lands there as goodwill, amortizable over 15 years under Section 197.8Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles Without the Section 338 election, a stock buyer would get no amortization deduction for that premium at all, because a plain stock purchase doesn’t create amortizable goodwill on the buyer’s books. That single point is often the largest tax benefit driving the whole election.
What the Buyer Gives Up: The Target’s Tax Attributes
Because the old target is treated as ceasing to exist, its accumulated tax attributes disappear. Net operating losses, unused tax credits, and other carryovers that belonged to the old target do not transfer to the new target. The new target starts with a clean slate: new asset basis, new depreciation schedules, no inherited losses.
A buyer counting on the target’s existing NOLs to offset future income needs to see this clearly. A Section 338 election eliminates that option. If those NOLs are valuable enough, a straight stock purchase without the election may be the better move.
How to Make and Report the Election
After the QSP closes, the buyer makes the election by filing IRS Form 8023.9Internal Revenue Service. About Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases For a 338(g), the buying corporation files on its own. For a 338(h)(10), the buyer and the selling consolidated group (or S corporation shareholders) jointly sign and file.3Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
The deadline is firm. Form 8023 must be filed by the 15th day of the 9th month after the acquisition date.10Internal Revenue Service. Instructions for Form 8023 Miss that date and the election is lost, unless the IRS grants late-election relief, which requires reasonable cause and isn’t guaranteed.
Form 8023 is only the first filing obligation. Both the old target and the new target must also file Form 8883, the Asset Allocation Statement, showing how the ADSP or AGUB was divided among the seven asset classes.11Internal Revenue Service. Instructions for Form 8883 – Asset Allocation Statement Under Section 338 Where each side attaches the form depends on the structure. An old target in a consolidated group under 338(h)(10) attaches it to the selling group’s consolidated return. An old target that is an S corporation attaches it to the Form 1120-S. An old target under a 338(g) attaches it to its standalone deemed-sale return. The new target attaches it to its first tax return after the acquisition date.
If the allocation to any asset changes after the initial filing year, which happens often given post-closing purchase price adjustments, the affected party must file an updated Form 8883 with the return for the year the change is taken into account. Failing to file a correct Form 8883 by the return’s due date without reasonable cause can trigger penalties under Sections 6721 through 6724.11Internal Revenue Service. Instructions for Form 8883 – Asset Allocation Statement Under Section 338 The IRS uses the buyer’s and seller’s Forms 8883 to cross-check each other, and any mismatch is a reliable audit trigger.
When Section 338 Isn’t Available: The 336(e) Alternative
Section 336(e) offers a similar deemed-sale mechanism for transactions that don’t qualify for a Section 338 election. The differences come down to who the buyer is and how the disposition happens. Section 338 requires the buyer to be a single corporation. Section 336(e) doesn’t. The buyer or buyers can be individuals, partnerships, LLCs, trusts, or any combination, which opens the mechanism to a wider range of deal structures.
Section 336(e) also applies to stock dispositions beyond straight purchases, including certain tax-free spin-offs and split-offs. The seller has to be a domestic corporation, or a consolidated group, disposing of at least 80 percent of a domestic subsidiary’s stock. Dispositions to related parties don’t count toward the 80 percent.
One hard rule: if a transaction qualifies for both a 338(h)(10) election and a 336(e) election, the 338(h)(10) election takes precedence and 336(e) is unavailable. Section 336(e) is the fallback for deals where the buyer isn’t a corporation, where multiple buyers are involved, or where the stock disposition happens across a series of transactions rather than a single purchase.