If you've spent any time in the world of buying or selling a business, you've probably heard someone mention a 338(h)(10) election — and then watched eyes glaze over around the room. It sounds like tax code jargon, and technically it is. But for business buyers and sellers, understanding this election can mean the difference between a deal that works financially and one that doesn't.

This article breaks it down in plain language: what the election is, how it works, who it helps, and who it hurts.

The Basics: Asset Sales vs. Stock Sales

To understand the 338(h)(10) election, you first need to understand the fundamental tension in most business acquisitions: the buyer wants to buy assets, and the seller wants to sell stock.

Why buyers prefer asset deals: When a buyer purchases assets, they get a 'stepped-up' tax basis in what they acquire. That means they can depreciate and amortize the assets from their new, higher purchase price — creating future tax deductions. They also avoid inheriting the seller's unknown liabilities.

Why sellers prefer stock deals: When a seller sells stock in a C-corp or S-corp, they typically pay capital gains tax on the proceeds — which is taxed at a lower rate than ordinary income. It's generally a cleaner, simpler transaction for the seller.

These two preferences are often in direct conflict. The 338(h)(10) election is a tool that attempts to bridge that gap — but not without trade-offs.

So What Exactly Is a 338(h)(10) Election?

A 338(h)(10) election is a joint tax election made by a buyer and seller that allows what is legally structured as a stock sale to be treated as an asset sale for federal income tax purposes.

In other words: the deal is documented as a purchase of stock, but the IRS treats it as if the buyer purchased all of the company's underlying assets. The target company is then treated as if it sold all of its assets at fair market value and then liquidated.

The election is governed by Section 338(h)(10) of the Internal Revenue Code and requires both parties to agree and file jointly (using IRS Form 8023). It cannot be made unilaterally.

Important eligibility note: A 338(h)(10) election is only available in specific deal structures. It applies when (i) a corporation acquires the stock of an S-corporation, or when (ii) a corporation acquires a subsidiary from a consolidated group (i.e., a subsidiary being sold by a corporate parent), and a corporate buyer must acquire at least 80 percent of the target’s voting power and value by purchase within a 12-month period. It is not available for standalone C-corp stock purchases between unrelated parties — that's where the related Section 338(g) election comes in, though that one is far less commonly used.

Who Benefits: The Buyer

The 338(h)(10) election is especially valuable to buyers, and the reason comes down to one concept: stepped-up basis.

When a buyer acquires stock without the election, they take over the company's existing tax basis in its assets — often very low, particularly in older businesses. That means little to no depreciation benefit going forward, and no deduction for goodwill or intangibles.

With the election, the buyer is treated as having purchased all the assets at their fair market value — the actual purchase price. This allows them to:

•          Depreciate tangible assets (equipment, property) from a higher starting value

•          Amortize intangible assets and goodwill over 15 years under Section 197

•          Avoid inheriting built-in gains of the target

•          Achieve the economic equivalent of an asset deal while enjoying the legal simplicity of a stock purchase

For a buyer acquiring a business with significant goodwill — think service businesses, professional practices, or companies with strong brand value — the tax savings from amortizing that goodwill can be substantial over the years following the acquisition.

In many cases, buyers will pay a premium purchase price in exchange for the seller agreeing to make the election, because the tax benefits to the buyer are real and quantifiable.

Who Benefits: Sellers in Certain Structures

While the election is primarily buyer-friendly, sellers can benefit in specific situations — particularly in S-corp transactions.

In a straight asset sale of an S-corporation, the proceeds flow through to the shareholders and are taxed once at the individual level — typically at capital gains rates for most of the gain. In a stock sale with a 338(h)(10) election, the outcome is largely the same: the gain is treated as flowing from a deemed asset sale through the S-corp to the shareholders.

For S-corp sellers, the economic impact of the election is often relatively neutral compared to a true asset sale — meaning they don't give up much. That's why the election is more commonly used in S-corp deals than anywhere else. The seller isn't penalized significantly, and the buyer gets the stepped-up basis they want. It can be the structural compromise that gets a deal done.

Additionally, sellers may use the election as a negotiating chip — agreeing to it in exchange for a higher purchase price from a buyer who values the tax benefit.

Who Is Negatively Impacted: The Seller (In Most Cases)

Here's where it gets complicated — and where sellers need to be very careful.

Because the election treats the transaction as an asset sale for tax purposes, the seller faces the tax consequences of a deemed asset sale, not a stock sale. This has two significant implications:

1. Ordinary Income on Certain Asset Categories. Not all business assets are taxed the same way. Some assets — like accounts receivable, inventory, and depreciation recapture on equipment — generate ordinary income when 'sold,' not capital gains. Ordinary income rates are significantly higher than long-term capital gains rates.

In a typical stock sale, the seller’s gain on the stock is generally capital gain, rather than a mix of capital gain and ordinary income from deemed asset categories. With the 338(h)(10) election, the gain is allocated across asset categories, and a portion of it may be taxed at ordinary income rates. Depending on the asset composition of the business, this can result in a meaningfully higher tax bill for the seller.

2. Double Taxation Risk in C-Corp Structures. This is the most important reason why the 338(h)(10) election is generally not available — or not advisable — in standalone C-corp transactions between unrelated parties.

In a C-corp, a deemed asset sale would trigger tax at the corporate level on the gain, and then the proceeds distributed to shareholders would be taxed again at the individual level. That's the classic 'double taxation' problem that makes C-corp asset deals painful for sellers. This is precisely why C-corp sellers typically fight hard to structure deals as stock sales, and why the 338(h)(10) election is rarely used (or even available) in those contexts.

S-corps avoid this problem because they are pass-through entities — income is taxed only once at the shareholder level. This is one of the core reasons that S-corp owners are generally much more amenable to a 338(h)(10) election than C-corp owners.

The Allocation of Purchase Price: Why It Matters

When a 338(h)(10) election is made, the purchase price must be allocated among the target company's assets using the 'residual method' under the Section 338 regulations — the same framework used in traditional asset deals under Section 1060.

The allocation is structured in a specific order of asset classes, from cash and cash equivalents through to goodwill and going concern value. This allocation determines how much gain falls into each tax category, which directly affects how much of the seller's gain is taxed as ordinary income versus capital gains.

Negotiating this allocation is one of the most important — and often overlooked — parts of any deal involving a 338(h)(10) election. Both parties have competing interests in how the purchase price is divided among asset classes, and the final allocation can significantly shift the tax burden in either direction.

Practical Considerations: When Does It Make Sense?

The 338(h)(10) election is not right for every deal. Here are the situations where it tends to make the most sense:

•          The target is an S-corporation with minimal depreciation recapture exposure

•          The buyer places significant value on goodwill and intangible assets that can be amortized

•          The buyer is willing to gross up the purchase price to compensate the seller for any incremental tax cost

•          The parties want the legal simplicity of a stock purchase combined with the tax benefits of an asset deal

•          The deal involves a corporate subsidiary being sold from a consolidated group

Conversely, it tends to be a poor fit when the target company has significant depreciation recapture exposure, when the seller has a low basis in assets subject to ordinary income treatment, or when the seller is a C-corporation selling on a standalone basis.

The Bottom Line

The 338(h)(10) election is a powerful tool that can bridge the gap between what buyers want (asset deal tax treatment) and what sellers want (stock deal simplicity and capital gains treatment) — but it comes with real costs that must be carefully modeled and negotiated.

For buyers, it is almost universally beneficial. For sellers, the answer depends entirely on the entity type, the asset composition of the business, the basis in those assets, and whether the buyer is willing to compensate for the incremental tax exposure.

Before agreeing to — or demanding — a 338(h)(10) election, both parties should have their tax advisors run the numbers. The difference in after-tax proceeds for the seller, or after-tax cost of ownership for the buyer, can be significant enough to change the economics of the entire deal.

This is not a decision to be made in a term sheet conversation. It belongs in a detailed financial and legal discussion — ideally before the letter of intent is signed.

Have Questions About Your Transaction?

At Auxo Law, we help buyers and sellers navigate the legal and structural complexities of business acquisition. If you're considering buying or selling a business and want to understand your options, we'd love to talk.