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Better late than never - new Section 336(e) regulations

USA
16 Jan 2014

27 years after the Tax Reform Act, the IRS published final Treasury regulations under Section 336(e), which is now operative for transactions occuring on or after 15 May 2013. Taxand USA discovers why this should be of interest to corporate taxpayers. 

Prior to the issuance of the Section 336(e) regulations, taxpayers wishing to characterise stock acquisitions as asset acquisitions for federal income tax purposes looked to Section 338, specifically Section 338(h)(10). It is important to note that when a Section 338(h)(10) election is made in connection with the acquisition of stock of a corporation, the actual sale of the stock is ignored for federal income tax purposes, and the federal income tax implications are determined solely with respect to the deemed sale of the assets, resulting in only one level of federal income tax imposed. The end result is that New Target receives a stepped-up tax basis in its assets equal to fair market value (with certain adjustments).

For the Section 336(e) election to be effectuated, there must be a qualified stock disposition, which is generally defined as a taxable disposition by a domestic corporation or the shareholders of an S corporation of at least 80% of the stock (as measured by vote and value) of a domestic corporation during a 12 month period. Provided there is a qualified stock disposition and the seller makes a Section 336(e) election, then the result is similar to what occurs in a Section 338(h)(10) election: 

  • Old Target is deemed to sell all of its assets to an unrelated third party and then liquidate
  • On the next day, New Target purchases its assets from the unrelated third party

The end result is that New Target receives a stepped-up tax basis in its assets equal to fair market value (with certain adjustments). Similar to a Section 338(h)(10) election, the federal income tax implications are determined solely with respect to the deemed sale of Old Target's assets, resulting in only one level of federal income tax imposed.

The Section 336(e) election can be thought of as a liberalised version of the Section 338(h)(10) election. While in the context of a Section 338(h)(10) election the focus is on the corporate buyer's acquisition of stock meeting various requirements, in a Section 336(e) election, the focus is on the seller and whether there is a qualified stock disposition. The buyer is not required to be a corporation as in a Section 338(h)(10) election. Also, as noted above, the Section 336(e) election is effectively made by the seller, while both the buyer and seller are required to make a Section 338(h)(10) election. 

Discover more: Better late than never - new Section 336(e) regulations


Your Taxand contacts for further queries are:
Keith Kechik
T. +1 312 288 4024
E. kkechik@alvarezandmarsal.com

Krista Lederer
T. +1 312 601 9076
E. kservidio@alvarezandmarsal.com

 

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Taxand's Take

The Section 336(e) election may be most appealing in circumstances in which the acquiring entity is an LLC or partnership. For example a private equity fund no longer needs to establish a corporate acquirer solely to facilitate a deemed asset acquisition. Taxpayers who acquire corporations for which a Section 336(e) election was made in connection with the acquisition may generally convert such corporations to LLCs, a move that generally confers pass-through treatment for federal income tax purposes, without incurring any incremental federal income tax. This is a significant benefit to taxpayers wishing to keep their structures in pass-through form. This may allow taxpayers to achieve what might be considered the Holy Grail of M&A tax planning: structuring a business such that a buyer receives a step-up in the tax basis of the acquired assets in a future acquisition (which should, in principle, increase deal value). 

Taxand's Take Author