The 338(g) Tax Election: What Searchers Need to Know About This Powerful Tax Tool

If you're acquiring a company through a stock purchase, you've probably heard about the 338(g) election. Maybe your accountant mentioned it during diligence. Maybe you saw it in the purchase agreement's tax provisions. Or maybe you're wondering whether you're leaving money on the table by not using it.

The 338(g) election is one of those tax provisions that can deliver significant value to buyers, but it requires careful planning and a willing seller. Understanding when to use it can make a meaningful difference to your deal economics.

What Is a 338(g) Election?

Section 338(g) of the Internal Revenue Code allows a buyer to treat a stock purchase as if it were an asset purchase for federal tax purposes. The practical impact is straightforward: you get a step-up in the tax basis of the target company's assets.

When you buy stock, you inherit the target company's existing tax basis in its assets. If the company bought equipment ten years ago for $100,000 and it's now fully depreciated, your tax basis is zero, even if you just paid $5 million for the entire company. That means no depreciation deductions going forward.

With a 338(g) election, you reset the basis of the target's assets to fair market value as of the acquisition date. This creates a depreciable basis in assets that were previously written down, generating valuable tax deductions in the years following your acquisition.

The Catch: You Need the Seller's Cooperation

The 338(g) election requires coordination with the seller because it triggers immediate tax consequences for them. The IRS treats the transaction as if the target company sold all of its assets at fair market value and then liquidated, creating a taxable gain at the corporate level.

In many deals, this makes the election a non-starter. Sellers structured as C corporations face double taxation: once at the corporate level on the deemed asset sale, and again at the shareholder level when they receive proceeds. Most sellers will refuse to accept this unless you compensate them for the additional tax hit.

However, the math changes when the target is an S corporation or an LLC taxed as a partnership. In these pass-through entities, the deemed asset sale results in only one level of tax, making the economics more workable for both sides.

How This Differs from 338(h)(10) and 336(e) Elections

The 338(g) election is often confused with its cousins, the 338(h)(10) and 336(e) elections. While all three allow buyers to get a stepped-up tax basis through a deemed asset sale, they work differently and are available in different situations.

A 338(h)(10) election is available when you're buying stock of an S corporation from its shareholders or acquiring a subsidiary from a consolidated corporate group. The key advantage is that the tax on the deemed asset sale flows through to the selling shareholders rather than creating a corporate-level tax. This eliminates the double taxation problem that makes 338(g) elections unattractive for C corporation targets. Because there's only one level of tax, sellers of S corporations are often more willing to agree to a 338(h)(10) election, sometimes with little or no purchase price adjustment.

A 336(e) election serves a similar purpose but applies when the target is a partnership or LLC. Like the 338(h)(10), it creates a deemed asset sale with tax consequences flowing to the partners or members rather than creating entity-level tax.

The practical takeaway: if you're acquiring an S corporation or an LLC, you'll likely be discussing a 338(h)(10) or 336(e) election rather than a 338(g). These elections are generally more favorable for both parties because they avoid double taxation. The 338(g) election typically only comes into play when you're acquiring a C corporation and the seller is willing to accept the tax hit in exchange for a higher purchase price, or in specific situations where the seller has attributes (like net operating losses) that can offset the deemed sale gain.

When Does a 338(g) Election Make Sense?

The decision comes down to cost-benefit analysis. Compare the present value of your future tax savings (from the stepped-up basis) against the additional purchase price you'll need to pay the seller to cover their increased tax liability.

Consider a scenario where you're acquiring a profitable software company structured as an S corporation. The company has significant goodwill and intangible assets with low tax basis. By making a 338(g) election, you can step up the basis in these intangibles and amortize them over 15 years. If the present value of those deductions exceeds the additional amount you need to pay the seller, the election makes economic sense.

This analysis becomes more compelling when:

• The target has significant goodwill or intangible assets with low tax basis

• The target's tangible assets are largely depreciated

• The seller is a pass-through entity (S corp or partnership)

• You have strong projected income to utilize the depreciation deductions

• Interest rates make future tax savings valuable in present value terms

  
  

Timing and Procedural Requirements

If you decide to pursue a 338(g) election, timing is critical. The election must be made jointly by the buyer and seller no later than the 15th day of the 9th month after the month of acquisition. For a June 15 closing, that's March 15 of the following year.

This deadline is unforgiving. Miss it, and you lose the opportunity entirely. This is why the decision should be addressed in your purchase agreement, not left until after closing.

The purchase agreement should specify:

• Whether the parties will make a 338(g) election

• How the additional tax cost will be calculated and allocated in the purchase price

• Who is responsible for preparing and filing the election forms

• Required cooperation between the parties

  
  

The Negotiation

In practice, 338(g) elections are most commonly seen in add-on acquisitions where a private equity buyer wants to maximize tax basis across a combined entity, and in deals involving pass-through entities where the tax cost is manageable.

When you raise the election in negotiations, expect the seller's advisors to calculate the incremental tax liability, add a gross-up, and present you with a figure. Your job is to compare that to the present value of your tax savings and determine whether the deal still makes sense.

Some sellers will refuse outright, particularly C corporations or those with specific tax planning reasons to avoid the deemed asset sale. Others will be open if you're willing to make them whole. The key is to raise the issue early in diligence so both sides have time to model the economics.

State Tax Considerations

While the focus on 338(g) elections typically centers on federal tax treatment, state tax consequences can be significant. Some states follow the federal treatment automatically, while others have their own rules or don't recognize 338(g) elections at all, creating a mismatch between federal and state tax treatment.

Before committing to a 338(g) election, work with your tax advisors to understand the state tax impact in every jurisdiction where the target operates.

The Bottom Line

The 338(g) election is a valuable tool for buyers, but it's not universal. It works best when the target is a pass-through entity with significant low-basis assets and when you have the income to utilize the resulting tax deductions.

If you're evaluating whether to pursue a 338(g) election in your next deal, start that conversation during diligence, not after signing. Run the numbers, understand the seller's tax position, and build the economics into your purchase price model. When used correctly, this election can deliver real value. When ignored or mishandled, it represents a missed opportunity that you can't recover after closing.