What is a Section 338(g) election and when is it used for foreign acquisitions?

Under IRC Section 338(g), when a U.S. corporation makes a "qualified stock purchase" (acquiring 80%+ of a target's stock within a 12-month period), it can elect to treat the stock purchase as an asset acquisition for U.S. federal tax purposes. The target corporation is deemed to have sold all of its assets at fair market value and then repurchased them — creating a new basis ("stepped-up" basis) in the assets. The old target is deemed liquidated, and a new target is deemed created. This election is available for both domestic and foreign target corporations, but it is particularly valuable for foreign acquisitions.

For domestic acquisitions, a Section 338(g) election triggers an immediate tax on the deemed asset sale, which usually makes it unattractive. But for a foreign target, the deemed asset sale occurs inside the foreign corporation — the gain is foreign-source income of the foreign entity, often subject to low or no immediate U.S. tax (depending on whether the target is a CFC and the character of the gain). The benefit is that the U.S. acquirer gets a stepped-up basis in the foreign target's assets, which increases QBAI for GILTI purposes (reducing future GILTI inclusions) and creates amortizable goodwill and intangible assets that generate future deductions.

The stepped-up basis in tangible assets directly increases the foreign target's QBAI, which increases the deemed tangible income return (DTIR) and reduces GILTI. If the acquisition price reflects significant goodwill, the 338(g) election can also create amortizable Section 197 intangibles (goodwill, going concern value), which reduce the CFC's tested income over the amortization period (typically 15 years). Both effects — higher QBAI and lower tested income — reduce the acquirer's GILTI inclusion.

Another benefit is that the 338(g) election eliminates the target's historical earnings and profits (E&P). The "new" target starts with zero E&P. This is valuable because it removes any accumulated Subpart F or untaxed E&P that could have generated inclusions or taxable dividends. For targets with complex E&P histories, this fresh start simplifies compliance and avoids potential tax traps from historical earnings.

The primary risk is foreign tax consequences. The deemed asset sale inside the foreign target may trigger foreign income tax in the target's jurisdiction if that country does not recognize the election or imposes tax on deemed dispositions. The U.S. election is a unilateral tax fiction — most foreign countries will not give effect to it, meaning no foreign tax may actually be paid on the deemed gain, and no stepped-up basis may be recognized locally. There may also be immediate Subpart F or GILTI consequences from the deemed sale (e.g., gains on inventory could be Subpart F income). Careful modeling of both U.S. and foreign tax impacts is essential.