If you are expanding your business by acquiring another company that is an S Corp, there is a tax-favorable way to structure the deal that allows you to make it a stock purchase while also having the transaction treated as a direct asset purchase for tax purposes.
When purchasing an S corporation, the usual approach is to buy the company’s assets, rather than its stock. This offers several benefits, including protection from legal responsibility for any unknown or contingent liabilities the S Corp may have. You can also step up the tax basis of the acquired assets to reflect the purchase price, generating more substantial tax deductions.
However, a direct asset purchase also has some disadvantages. For one, you will need to transfer title of each asset, which can result in additional legal fees, especially if there are multiple assets to transfer. In addition, the S Corp you are acquiring may have valuable intangible assets that are not easily transferable, such as contracts, licenses, and leases. In many cases such non-transferable assets are the core of a company’s value.
A viable alternative is to purchase the stock of the target company, and then to have both buyer and seller make a Section 338(h)(10) election. The acquired S corporation continues to exist as a legal entity, but the acquiring company owns all of its stock.
This allows you to treat the acquisition as an asset purchase for tax purposes, even though it is legally structured as a stock purchase. One additional step is generally required: a professional appraisal to establish the initial tax basis for specific assets.
This election still gives you the option, as the purchasing company, to step up the tax basis of acquired assets, but also gives you control of all intangible assets. This approach has the added advantages of keeping any unknown liabilities within the S Corp, protecting the buyer.
For the S Corp the tax treatment is the same as if it had sold its assets, paid its liabilities, and then liquidated. Gains from the asset sales are passed through to the S corporation’s shareholders.
Taking this route to gain the tax advantages of an asset purchase with the expanded control of all tangible and intangible assets is a win-win for many businesses when making an acquisition of an S corporation. Like all tax-related decisions, you should consult a qualified accountant or tax advisor before proceeding.
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