In most business sales, buyer and seller start on opposite sides of a single question: asset deal or stock deal? Buyers usually want to buy assets—they get a stepped-up tax basis and can leave unwanted liabilities behind. Sellers usually prefer to sell stock—one level of tax, and mostly capital gain. But sometimes a stock sale is the only practical route, because the company holds contracts, licenses, or permits that are difficult to reassign. Three elections under the Internal Revenue Code—Sections 338(g), 338(h)(10), and 336(e)—let the parties keep the legal form of a stock sale while getting the tax treatment of an asset sale. Done right, the buyer gets a basis step-up and the deal still closes as a transfer of stock.
Why the step-up is worth fighting over
When a buyer simply purchases stock with no election, it inherits the target’s existing “carryover” basis in the company’s assets—there is no step-up. With an election, the target is treated as if it had sold all of its assets at fair market value, so the buyer takes a fresh, stepped-up basis. That lets the buyer depreciate the equipment again and amortize goodwill and other intangibles over 15 years under Section 197, sheltering future income. Those future tax savings are real money—and they are usually what a buyer is paying for when it asks for an election.
Section 338(g): the buyer-only election
A Section 338 election is available when a corporation makes a “qualified stock purchase”—acquiring at least 80% of the target’s stock, by vote and value, within a 12-month period. The plain Section 338(g) election is made by the buyer alone. The catch is double taxation: the deemed asset sale triggers a corporate-level tax on the target, and the selling shareholders are still taxed on the actual stock sale. For a typical domestic C corporation, that second layer usually makes a 338(g) election uneconomic. In practice it shows up mainly where the target is a foreign corporation, or where the target has net operating losses or credits that absorb the deemed-sale gain.
Section 338(h)(10): the joint election
This is the election most small-business sellers will actually encounter. A Section 338(h)(10) election is made jointly by the buyer and the seller, and it collapses the two levels of tax into one. The deemed asset sale is taxed to the seller—the S corporation’s shareholders, or a selling consolidated group—and the actual stock sale is ignored. The buyer gets its step-up; the seller is taxed roughly as if it had sold the assets directly.
Two eligibility limits matter. The target must be an S corporation or a subsidiary that is a member of an affiliated or consolidated group, and the buyer must be a corporation. For an S-corp target, every shareholder—including any who are not selling—must consent, and the company’s S election has to be valid. A defective S election discovered in diligence can unravel the entire structure, which is one more reason to confirm S status long before closing.
The catch for sellers: character, recapture, and built-in gains
Asset-sale treatment is not free to the seller. Allocating the purchase price across the assets can convert what would have been capital gain into ordinary income—most often through depreciation recapture on equipment and other “hot” assets—which is taxed at higher rates. An S corporation that used to be a C corporation can also face the built-in gains tax under Section 1374 if it sells within the recognition period. Because the election can push the seller’s tax bill above what a plain stock sale would cost, sellers routinely negotiate a “gross-up”: the buyer pays enough extra to leave the seller no worse off than without the election. Whether the step-up is worth that payment is a math problem both sides should run before signing.
Section 336(e): when the buyer isn’t a corporation
Section 338(h)(10) has a blind spot—it works only if the buyer is a corporation. Many of today’s buyers are not: private equity funds, individuals, and LLCs taxed as partnerships. Section 336(e) fills that gap. It provides nearly identical asset-sale treatment for a “qualified stock disposition”—a sale, exchange, or distribution of at least 80% of a target’s stock within 12 months—without the corporate-buyer requirement, and it even allows dispositions to more than one buyer. Just as important, the 336(e) election is made by the selling side (the S corporation and its shareholders, or the selling corporate parent) together with the target—not jointly with the buyer. For an S-corp owner selling to a PE fund or an individual, Section 336(e) is often the tool that delivers the buyer’s step-up when a 338(h)(10) election simply isn’t available.
What this means for your purchase agreement
- Decide the structure early. An election changes who bears how much tax, and that belongs in the price—not in a dispute after closing.
- Put the allocation in writing. The deemed asset sale requires allocating the price across asset classes under the Section 1060 residual method (reported on Form 8883); attach an agreed schedule so both sides file consistently.
- Sellers: model the ordinary-income and recapture hit, and negotiate a gross-up so the election leaves you whole.
- Buyers: quantify the present value of the step-up—it can justify paying that gross-up and still come out ahead.
- Mind the deadlines. A Section 338 election is filed on Form 8023, due by the 15th day of the ninth month after the acquisition date; a Section 336(e) election is made by statement on timely-filed returns.
- Confirm eligibility before you rely on it: the 80% threshold, a valid S election, and whether the buyer is a corporation.
One more option worth raising with your advisors: for many S-corp sales, a pre-closing “F reorganization” followed by a sale of LLC interests now achieves a comparable step-up while sidestepping some of these eligibility traps. Which path is best depends on the parties, the assets, and the numbers—so the time to model it is before the letter of intent, not after.
If you have questions about structuring the purchase or sale of a business or other services, you can reach us at martinkreshon.com, northcitylaw.com, or call (206) 929-0609. You can also find reviews for Martin on Google and Avvo.