What is IRC 338 and when would a foreign buyer use a Section 338 election when acquiring a U.S. company?

IRC 338 provides an election that allows a 'qualified stock purchase' — the acquisition of at least 80% of a target corporation's stock within a 12-month period — to be treated as if the target corporation sold all its assets and then was reconstituted as a new corporation. This is called a 'deemed asset sale.'

The primary benefit is a step-up in the tax basis of the target's assets to their fair market value. This higher basis generates larger depreciation and amortization deductions going forward, reducing the acquiring group's future taxable income.

IRC 338(g) is the general election available to any qualified purchaser. For foreign acquirers, the Section 338(g) election is particularly attractive because:

1. The deemed asset sale occurs inside the target U.S. corporation. The gain on the deemed sale is the target's income, taxed at the U.S. corporate rate (21%). 2. The foreign acquirer does not directly realize any U.S. taxable gain — the stock purchase itself is generally not subject to U.S. tax for the foreign buyer. 3. After the election, the target corporation has a stepped-up basis in all its assets.

For a domestic acquirer, the 338(g) election creates a tax cost (the target pays tax on the deemed sale gain) without a corresponding tax benefit for the acquirer (who already has a cost basis in the stock). This is why domestic acquirers typically use Section 338(h)(10) instead, which is only available when both parties are in a U.S. consolidated group.

The 338(g) election is advantageous for foreign acquirers when:

- The target's assets have significant built-in gain (fair market value exceeds tax basis) - The target has tax attributes (like NOL carryforwards) that can offset the gain from the deemed sale - The step-up in basis generates substantial future depreciation/amortization deductions - The present value of future tax savings from the stepped-up basis exceeds the current tax cost of the deemed sale

The election is also valuable when the foreign acquirer plans to operate the U.S. business long-term and wants maximum deductions to reduce future U.S. taxable income.

When the 338(g) election is made:

1. The target corporation is treated as having sold all its assets at fair market value on the 'acquisition date' 2. The target recognizes gain or loss on the deemed sale 3. The target is then treated as a new corporation that purchased all the assets at fair market value 4. The new corporation's basis in the assets equals the 'adjusted grossed-up basis' (AGUB), calculated based on the stock purchase price, assumed liabilities, and other adjustments

The election must be filed on Form 8023 no later than the 15th day of the 9th month beginning after the month of acquisition.

Before making the election, evaluate:

- Tax cost: The deemed sale generates immediate tax liability for the target. Does the target have enough NOLs or other attributes to shelter the gain? - Present value analysis: Will the stepped-up basis produce enough future tax savings to justify the current tax cost? - Asset composition: The benefit is greatest when assets have short depreciable lives and large fair market value premiums over book basis - Goodwill and intangibles: The stepped-up basis allocated to goodwill is amortized over 15 years under IRC 197 - State tax implications: Many states conform to the federal 338(g) election, but some have different rules

A detailed financial model comparing the after-tax economics with and without the election is essential before making this decision.