The 338(h)(10) Exchange - The Best of Both Worlds
by: Craig Watrous
In any business purchase the tax consequences of the deal structure need to be carefully evaluated. Not reviewing the tax implications can have serious consequences for both the buyer and the seller. There are generally two ways to sell a business, a stock sale or an asset sale. For the seller, it’s money well spent to have an M&A experienced accountant crunch the numbers from the purchase price valuation figures and determine what the actual, after tax, take home amount will be from both structures. For the buyer its critical to review the tax implications and determine what legitimate deductions are available.
These calculations will help guide the decision regarding the type of transaction (asset or stock sale), that will take place and may also significantly impact the type of buyer who will be willing to acquire the business. Most buyers will want an asset sale and are going to fight hard to get it. Remember the Golden Rule: he who has the gold makes the rules. Often it’s the buyer who makes the final decision regarding the deal structure. Buyers usually want asset sales because they allow them to purchase the target’s assets, take a ‘step up’ in the basis of the assets, and recognize the immediate benefits of depreciating them. The buyer also avoids having to assume liability for the company’s past operations. On the flip side, stock sales allow the seller to realize the purchase price at a favorable capital gains tax rate. Also, it makes the transition between the buyer and the seller smoother. However, there are far fewer tax advantages for the buyer in a stock sale, stock isn’t depreciable.
Depending on the seller and buyer’s corporate structures an 338(h)(10) exchange could be a practical and mutually beneficial alternative. A 338(h)(10) permits the seller to sell the business stock for legal purposes and the buyer to acquire the business assets for tax purposes. Rather than try to recreate the wheel, Forbes Magazine has done a great job of explaining what a 338(h)(10) transaction looks like and its general impacts on an M&A deal.
There are explicit tax and legal requirements that must be met to qualify for a 338(h)(10) exchange. These should be explored early in the process with legal and tax advisors to see if your transaction qualifies for a 338(h)(10) exchange.
(Mallon Lonnquist Morris & Watrous, PLLC, is a business, employment, real estate, and litigation law firm. Craig T. Watrous is a Colorado M&A attorney and partner at MLMW, based in Denver, Colorado. Craig regularly represents clients on both sides of 338(h)(10) transactions. Craig can be reached at firstname.lastname@example.org and (303) 722-2165.)