Many agencies are still being bought as corporate purchases, especially in-house internal ownership transitions. One of the issues reflected in a stock sale is the fact that the “basis” of the agency does not get stepped up to the current value (all or a portion of the purchase price). Even though you pay for the agency, when it comes time to sell it again, your basis is the same as the basis of the owner from whom you purchased it – often zero. This means that you will have a substantial tax burden at the end of your ownership even though you paid a full fair market price for the business when you bought it. You will be taxed (at whatever rate is current for Capital Gains) for the difference between BASIS (the basis of value of the agency before you bought it, which is often zero if you buy it from the agent who began and built the business).
One of the benefits of an asset sale is that, since you are paying the seller for his asset, you get it at the new, “stepped up” basis, and you will not have to pay tax on the amount that YOU spent to purchase it when it comes time for you to sell the business. Your tax obligation will be for the amount ABOVE what you spent (your basis of value).
A Section 338 election, in short, allows you to treat a corporate purchase like an asset sale for stepped up basis AND it permits you to amortize the cost of the agency as a deductible tax expense over the 15-year period mandated by the IRS for intangible asset purchases.
Section 338 provides two elections: the so-called “regular Section 338 election” under Section 338(g), and the other under Section 338(h)(10). These elections treat a stock acquisition as an asset acquisition for federal income tax purposes. A Section 338 election is useful when the buyer has a good business reason to acquire stock rather than assets (e.g., difficulty in re-assigning licenses), but the buyer still wants the tax benefits of an asset acquisition.
Section 338(h)(10)
A Section 338(h)(10) election is much more common than a Section 338(g) election because the 338(g) election results in two levels of tax, whereas a 338(h)(10) election results in only one. In a regular Section 338 election, two levels of tax are imposed: one on the shareholders upon their sale of the target stock and the other on the deemed asset sale by the target corporation (“Old Target”).
In a Section 338(h)(10) election, typically, only one level of tax is imposed on the deemed asset sale; the stock sale is ignored for tax purposes, and the deemed liquidation is tax-free to the selling shareholders.
There are a lot of ‘i’s’ to be dotted and ‘t’s’ to be crossed before this becomes the proper tool for you, but too many acquiring agents aren’t even aware of this opportunity. The typical problems with corporate purchases (i.e. the acquisition of agency liabilities, known or hidden, are included) but if that’s not an issue and if the savings in taxes caused by amortizing the cost of the acquisition are more beneficial than the downside, the taxable gain on the deemed asset sale, this could make sense for you.
Please call me if you would like to speak about the acquisition of an agency or the internal or external perpetuation of yours including the potential for a Section 338 election. Remember there are as many ways of ‘skinning the ownership transfer cat” as there are agencies in the U.S. Talk to your tax accountant or tax attorney about the potential for a local professional’s advice on the subject.