What Is the 338(h)(10) Election and How Does It Work?

A Section 338(h)(10) election is a joint tax election by a buyer and seller that treats the purchase of a corporation’s stock as if the corporation had instead sold all of its assets and then liquidated. The deal closes as a stock sale under state law, with contracts, licenses, and permits staying in place, but federal income tax applies as though assets changed hands. The buyer gets a stepped-up basis in the target’s assets and the depreciation and amortization that come with it. The seller reports the gain from a deemed asset sale rather than from the sale of stock. The election is available only in specific structures, most commonly the sale of an S corporation or of a subsidiary in a consolidated group.¹

Why Parties Use It

Every acquisition faces a structural tension. A buyer purchasing stock inherits the target’s low tax basis in its assets and the limited deductions that come with it. A buyer purchasing assets gets a fresh, stepped-up basis, but the target recognizes gain on the sale, and for a C corporation that gain is taxed again when proceeds reach the shareholders. Most C corporation sellers refuse to accept that double tax.

The 338(h)(10) election resolves the conflict. The parties sign a stock purchase agreement and keep the legal mechanics simple. For tax purposes, the IRS pretends the target sold its assets and liquidated. The buyer walks away with the stepped-up basis it wanted. When the target is an S corporation, the gain flows through to the shareholders’ individual returns as a single level of tax. When the target is a subsidiary in a consolidated group, the deemed liquidation to the selling parent is generally tax-free.

Who Qualifies

The transaction must be a “qualified stock purchase”: a purchasing corporation must acquire at least 80% of the target’s total voting power and 80% of the total value of its stock, by purchase, within a 12-month period. The 12-month clock starts on the date of the first qualifying purchase.¹

Not every way of acquiring stock counts. Stock obtained through tax-free exchanges, gifts, inheritances, or transactions with related parties is excluded.¹ The buyer must itself be a corporation. An individual, a partnership, or a private equity fund structured as a partnership cannot make the election. That exclusion is the main reason the related Section 336(e) election exists, discussed further below.

The target must fit one of these categories:

An S corporation immediately before the acquisition date. This is the most common scenario because the single-level tax benefit is greatest here.
A subsidiary in a consolidated group whose selling parent files a consolidated federal return.
A member of a non-consolidated affiliated group.

Ineligible corporations, such as foreign corporations and regulated investment companies, cannot be the target.

Both Sides Must Consent

A buyer cannot make this election unilaterally. For a consolidated group target, the common parent of the selling group must sign. For an S corporation target, every shareholder must consent, including shareholders who are not selling their stock in the transaction. That unanimous consent requirement gives selling shareholders real leverage, since the buyer’s stepped-up basis depends entirely on them agreeing. The commitment to make the election is usually written into the stock purchase agreement itself, often paired with indemnification covering the tax that flows from the deemed asset sale. Once filed, the election is irrevocable.²

How the Deemed Transaction Works

Every tax consequence of the election flows from a two-step fiction: a deemed asset sale followed by a deemed liquidation.

The Deemed Asset Sale

The target as it existed before the election (“Old Target”) is treated as having sold every one of its assets to an unrelated party in a single transaction at the close of the acquisition date.² The sale price is not the amount the buyer actually paid for the stock. It is a calculated figure called the Aggregate Deemed Sale Price (ADSP), determined under Treasury Regulation Section 1.338-4.³ The ADSP is generally the grossed-up amount realized on the recently purchased stock plus the target’s liabilities. Gain or loss is calculated asset by asset, based on the difference between each asset’s share of ADSP and its existing tax basis.

The Deemed Liquidation

Immediately after the deemed asset sale, Old Target is treated as having liquidated and distributed the sale proceeds to its shareholders. The tax treatment of that distribution depends on who the seller is:

For a consolidated group subsidiary, the liquidating distribution to the selling parent is generally tax-free under Section 332.⁴
For an S corporation, the deemed asset sale gain flows through to the shareholders and increases their stock basis. The deemed liquidating distribution is then generally tax-free to the extent of that adjusted basis.

That flow-through is what produces the single level of tax. Each S corporation shareholder’s final stock gain or loss is the difference between the distribution and the adjusted stock basis after accounting for the deemed asset sale gain.

New Target Picks Up the Assets

Once Old Target ceases to exist for tax purposes, a “New Target” is treated as having purchased the assets for the Adjusted Grossed-Up Basis (AGUB), calculated under Treasury Regulation Section 1.338-5.⁵ AGUB is the buyer-side deemed purchase price: the grossed-up basis of the recently purchased stock, assumed liabilities, and related acquisition costs. New Target starts fresh for tax purposes. The actual legal entity, meanwhile, continues to exist with the same name, contracts, licenses, and permits. The fiction exists solely for federal tax reporting.

What It Means for the Buyer

The payoff is a higher tax basis in the target’s assets, which translates into bigger deductions. AGUB is allocated across the assets using the residual method, and the buyer then depreciates or amortizes each asset over its applicable recovery period. If the target held assets with historical basis well below fair market value, the step-up can be substantial. At the current 21% federal corporate tax rate, a $10 million step-up in depreciable assets produces roughly $2.1 million in federal tax savings over the recovery periods. The present value of those future deductions is usually the central number in the deal model.

New Target is treated as a new corporation. It can adopt a new tax year, choose a new accounting method, and is not bound by Old Target’s tax elections. It does, however, remain liable for Old Target’s unpaid tax obligations, including the tax from the deemed asset sale itself.² That inherited liability is typically covered by indemnification in the purchase agreement.

What It Means for the Seller

The deemed asset sale changes the character of the gain. Instead of a single capital gain on the sale of stock, S corporation shareholders report whatever mix of ordinary income and capital gain the target’s assets produce. Depreciation recapture on equipment and real property generates ordinary income. Gain on capital assets and goodwill is taxed at capital gains rates. The mix matters because ordinary rates can be significantly higher.

For S corporation sellers, the gain flows through to each shareholder’s return in proportion to ownership. For a consolidated group subsidiary, the deemed asset sale gain is reported on the selling parent’s consolidated return, and the subsequent deemed liquidation is generally tax-free under Section 332.⁴

Net Investment Income Tax

S corporation shareholders who do not materially participate in the target’s business owe an additional 3.8% tax on their share of the deemed asset sale gain. Section 1411 imposes this net investment income tax on gains from property used in a passive activity and on the deemed sale of an S corporation interest to the extent of unrealized gain in the corporation’s assets.⁶ Active shareholders are exempt. Deals with a mix of active and passive owners need to model this tax separately for each shareholder.

Allocating the Purchase Price

Both ADSP and AGUB must be allocated across the target’s assets using the residual method required by Section 1060, and the allocation must be consistent between buyer and seller.⁷ The method fills seven asset classes in order:⁸

Class I: cash and bank deposits
Class II: actively traded securities and certificates of deposit
Class III: debt instruments and accounts receivable
Class IV: inventory
Class V: all other tangible and intangible assets not in another class
Class VI: Section 197 intangibles other than goodwill, such as customer lists, patents, and non-compete agreements
Class VII: goodwill and going concern value

Total consideration is reduced by Class I assets, then allocated to each successive class up to the fair market value of the assets in that class. Whatever is left after Classes I through VI falls into Class VII as goodwill.⁹

The Class VII residual is where negotiations get contentious. Goodwill is amortizable over 15 years under Section 197, providing steady annual deductions for the buyer.¹⁰ From the seller’s side, gain allocated to goodwill is typically capital gain, while gain on inventory or depreciated equipment can be ordinary. Both sides have incentives to push the allocation different ways, but the consistency requirement forces agreement.

The Economic Trade-Off

The election creates value when the buyer’s future tax savings from the stepped-up basis exceed the seller’s increased tax cost from reporting a deemed asset sale instead of a stock sale. Negotiation then becomes a question of splitting the surplus.

In practice, the buyer calculates the present value of its incremental depreciation and amortization deductions at the applicable tax rate. The seller calculates how much additional tax the deemed asset sale costs compared to a straight stock sale. The purchase price is then “grossed up” so the seller walks away with the same after-tax cash as in a stock sale, while the buyer still comes out ahead on a net present value basis.

If the present value of the buyer’s benefit does not exceed the seller’s added tax cost, the election destroys value and the parties should do a straight stock deal. Small changes in discount rates, holding periods, or the ordinary-versus-capital mix can flip the analysis. The gross-up calculation is often the most heavily negotiated exhibit in the purchase agreement.

Filing Requirements and Deadlines

The election is made on Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases. It must be filed by the 15th day of the ninth month after the acquisition date.¹¹ Both the purchasing corporation and either the selling consolidated group parent or every S corporation shareholder must sign it.¹²

Buyer and seller must also each file Form 8883, Asset Allocation Statement Under Section 338, with their income tax returns for the year of the acquisition.⁸ Form 8883 reports the allocation of ADSP and AGUB across the seven asset classes, and the amounts on the two versions must match. Inconsistencies draw IRS scrutiny.

For an S corporation target, the deemed asset sale is reported on a final Form 1120-S filed for Old Target, covering the short tax year ending on the acquisition date.¹³ For a consolidated group target, the sale appears on the selling parent’s consolidated return.

Relief for a Missed Deadline

Missing the Form 8023 deadline does not always kill the election. Revenue Procedure 2018-58 provides an automatic extension when the election is made on or before the due date (including extensions) of the target corporation’s return for the year of the deemed sale. The election must be attached to a timely filed original return, or an amended return filed before that due date, for the selling corporation, the target, or the purchasing corporation.¹⁴ Once that automatic window closes, the parties generally must seek a private letter ruling, which is expensive, slow, and not guaranteed. The safer approach is to file Form 8023 well before the nine-month deadline and build the filing into the closing checklist.

When Section 336(e) Is Used Instead

Section 336(e) is a related election that also produces a deemed asset sale, and the regulations state that the results should generally coincide with those of Section 338(h)(10). The critical difference is eligibility. A 338(h)(10) election requires the buyer to be a corporation. A 336(e) election does not: the buyer can be an individual, a partnership, a trust, or any other type of person.¹⁵

This distinction matters in private equity. When a PE fund structured as a partnership acquires an S corporation, a 338(h)(10) election is off the table because the buyer is not a corporation. Section 336(e) can fill the gap, provided the seller is a domestic corporation (or the S corporation shareholders) that disposes of at least 80% of the target’s stock within a 12-month period. Section 336(e) also covers stock distributions, which 338(h)(10) does not; a taxable spin-off can be treated as a deemed asset sale. The 336(e) election is made solely by the seller, without any buyer signature.

Traps That Can Undercut the Benefit

Built-In Gains Tax for Former C Corporations

If the target S corporation was formerly a C corporation, a corporate-level built-in gains tax under Section 1374 may apply to the deemed asset sale. This tax hits the net recognized built-in gain at the highest corporate tax rate (currently 21%) during a five-year recognition period that begins when the corporation elected S status.¹⁶ A conversion from C to S status less than five years before the acquisition date can therefore trigger an additional corporate-level tax on appreciation that existed at conversion. That effectively reintroduces a partial double tax and can significantly reduce the deal economics. Once the five-year recognition period has passed, the trap is gone.

State Tax Nonconformity

Not every state follows the federal treatment. Most conform, but some treat the gain as nonbusiness income sourced to the seller’s state of domicile rather than business income apportioned across states. A few states allow parties to make a state-level 338(h)(10) election independently of whether one is made federally. The mismatch can create unexpected state tax bills for the seller or complicate basis calculations for the buyer. Modeling the state impact on a state-by-state basis is a necessary step in any multi-state deal.

Installment Notes

When the buyer pays with installment notes rather than all cash, the deemed asset sale can qualify for installment reporting under Section 453. The regulations treat Old Target as receiving “new target installment obligations” with terms identical to the actual purchase notes.² Old Target then distributes those obligations to the selling shareholders in the deemed liquidation. For S corporation shareholders, that distribution is not itself a taxable event; they report gain as payments are received, spreading the tax over time. ADSP is adjusted when actual payments differ from the original amount realized. Installment treatment does not apply to assets ineligible for it, such as inventory and depreciation recapture on personal property.

Contingent Liabilities and Earn-Outs

When contingent liabilities surface or are paid after the acquisition date, both ADSP and AGUB are adjusted. An amended Form 8883 must be filed when the purchase price shifts due to earn-outs, indemnification payments, or the resolution of contingent claims. These adjustments can retroactively change the gain the seller reports and the basis available to the buyer, which is why deal agreements usually include detailed true-up provisions.

1
Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions
2
eCFR. 26 CFR 1.338(h)(10)-1 – Deemed Asset Sale and Liquidation
3
eCFR. 26 CFR 1.338-4
4
Office of the Law Revision Counsel. 26 USC 332 – Complete Liquidations of Subsidiaries
5
eCFR. 26 CFR 1.338-5
6
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
7
Office of the Law Revision Counsel. 26 USC 1060 – Special Allocation Rules for Certain Asset Acquisitions
8
Internal Revenue Service. Instructions for Form 8883
9
eCFR. 26 CFR 1.1060-1 – Special Allocation Rules for Certain Asset Acquisitions
10
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
11
Internal Revenue Service. Instructions for Form 8023
12
Internal Revenue Service. About Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases
13
Internal Revenue Service. 2025 Instructions for Form 1120-S
14
Internal Revenue Service. Revenue Procedure 2018-58
15
eCFR. 26 CFR 1.336-1 – General Principles, Nomenclature, and Definitions for a Section 336(e) Election
16
Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-In Gains