Consider a Sec 336(e) Election When Planning an Acquisition or Sale Transaction

When negotiating your next business acquisition or sales transaction, don’t be so quick to dismiss an election under Section 336(e) that might be ideal in your particular circumstances. Regulations were recently issued that provide finality, as well as some long awaited perks.

Background

Enacted as part of the 1986 Tax Reform Act, the Sec 336(e) regime election was intended as a relief provision that would help certain corporate entity taxpayers that were negatively impacted due to the repeal of the General Utilities doctrine and were not eligible to qualify for deemed asset sale tax treatment under a Sec 338(h)(10).

As originally constructed, the Sec 336(e) election basically stated that, under regulation to be prescribed by the Secretary, a corporation that owned at least 80% of the voting shares and value of another corporation, could sell, exchange or distribute all of its ownership in such corporation and be eligible to make an election to treat such sale, exchange, or distribution as a disposition of all of the assets of such corporation, and no gain or loss would be recognized on such sale, exchange, or distribution of such stock. The Sec 336(e) election provision, as originally enacted, was a mere promise awaiting interpretation from the Treasury. Furthermore, there were many unanswered questions, including:

• What type of corporation would qualify (e.g., Can a foreign corporation qualify? Can an S Corporation be a target?)
• What was meant by selling, exchanging, or distributing all its stock ownership (e.g., Is at least the 80% threshold good enough? Can you aggregate ownership within a selling affiliated group?)
• How the deemed asset sale would mechanically work (e.g., Like a Sec 338(h)(10) sales transaction?)
• Are the tax attributes (e.g., NOLs, unused credit carried forward, etc.) transferred to the new owner?

All of these questions have now been addressed with the issuance of the final regulation covering qualified stock dispositions transacted on or after May 15, 2013.

Ideal Scenarios for a Potential Sec 336(e) Election

The election under Sec 336(e) should be considered under the following scenarios:

• A qualified target stock acquisition with large unused NOLs and general business credit that would be able to mitigate the tax attributable to the deemed asset sale gain
• A qualified target stock acquisition with high tax basis assets that again would be able to offset the gain realized from the deemed asset sale
• To accommodate a qualified purchaser that does not qualify for a Sec 338(h)(10) election because it is not a qualified buyer entity (e.g., another S Corporation or consolidated filing group)

Under all the above scenarios, a present value tax calculation analysis should be performed to quantify:

1. The additional tax to be paid by the selling party from the deemed asset sale, compared to a stock sale with no election
2. Tax benefit to be enjoyed by the buying party in the future from the write-off attributable to the stepped-up basis adjustment (i.e., up to fair market value) for the assets deemed acquired from the seller.

Depending on buyer’s internal rate of borrowing/raising capital and other business factors beyond the scope of this blog post, the buyer might be willing to partially or fully reimburse the seller for making the election.

In summary, if you do not qualify for Sec 338(h)(10) joint election filing, which is always controlling, a Sec 336(e) election might be appropriate for you in your next business acquisition or contemplated sales transaction.

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