338(h)(10) Sale: 3 Things Business Owners Should Know

By: Scott Sturgeon, JD, MBA, CFP®

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You’ve done it. After working for years building your business, you’ve finally decided it’s time to sell and move on to something else in life (admittedly a whole different topic within itself). If only you can make it through all the twists & turns of the sales process!

If you’re reading this article, there’s a good chance you’ve already received an offer from a counter-firm to buy out your ownership interest or the entirety of the business itself. Even if you haven’t, as part of the offer process, certain companies may include a provision as part of their offer making the transaction what is referred to as a 338(h)(10) sale.

So what is a 338(h)(10) sale?

Why would an acquiring company or a private equity firm want to make the deal a 338(h)(10) sale?

Perhaps most importantly, what does a 338(h)(10) sale mean to you the buyer in determining what your net proceeds from the sale will be?

If these kinds of questions are top of mind, read on to learn how we help business owners make informed decisions about the best approach for their unique circumstances.

What is a 338(h)(10) sale?

Selling a business is a surprisingly complex process that involves careful consideration of various options. One option that business owners are often confronted with is the 338(h)(10) sale, a specific type of transaction that can have both advantages and disadvantages to a seller.

A 338(h)(10) sale refers to Section 338(h)(10) of the US Tax Code, which effectively allows an acquiring company to treat the purchase of a company’s stock like it was purchasing their assets instead. The reason a buyer might want to do that is because it allows them to step up the cost basis of the assets they are buying to the fair market value of those assets at the time of purchase, something they could not do if they were purchasing the stock of the company instead.

For example, rather than buying shares of a company for $100 with a built-in capital gain of $50, the buyer can basically buy those same shares for the same $100 with minimal capital gains included in the purchase price. The net result of that can make for significant tax savings for the buyer as their cost basis in the acquired firm is basically zero. However, the same can’t be said for the business seller & that can make for some adverse tax implications when it comes time to pay taxes on the sale proceeds.

Would a seller want a 338(h)(10) sale?

The answer is slightly complicated. In short, a 338(h)(10) might create a negative tax consequence for you as the seller because it treats some or all of the proceeds like you’re earning ordinary income, rather than as a capital gain.

Ordinary income is generally taxed less favorably than capital gains. It’s kind of analogous to an IRA versus a taxable brokerage account. Any money coming out of an IRA is taxable as ordinary income, similar to how you’re taxed as a W2 employee. With a taxable brokerage account however, the sale of stocks in your account may be subject to capital gains tax, which is generally more favorable than ordinary income. Since some or all of your sale proceeds are taxed higher as ordinary income as the seller, you may end up paying more in taxes on the sale of your business in a 338(h)(10) sale.

Conversely, the reason a seller might benefit from a 338(h)(10) sale is actually for the same reason listed above. Since the seller is facing a much larger tax bill than they otherwise might be with a straight up stock sale, you may have more leverage to negotiate a higher sales price to offset or eliminate the impact of those adverse tax consequence.

What are the limitations of a 338(h)(10) sale?

The biggest limitation preventing the sale of a business from being designated a 338(h)(1) sale is that the buyer must be either a C-Corporation or an S-Corporation. The seller must be a corporation as well (albeit with more flexibility than the buyer). Additionally, proceeding with a 338(h)(10) sale must be mutually agreed upon by both the buyer and seller.

Should a seller proceed with a 338(h)(10) sale?

Much like anything in life, it depends! Selling a business could be the largest financial transaction you experience in your life, so making sure you do it correctly & that the proceeds are sufficient to align with your financial goals over the long term is critical.  

At Oread Wealth Partners, we help our business owner clients make major decisions just like this. Working with our clients & other tax professionals, we can build projections to determine what net sale proceeds might look like from selling your business & what amounts might be needed to achieve your financial goals. If you’re looking to exit or sell your business & are feeling lost in navigating the sale process, consider reaching out & scheduling some time via the link below for a no-obligation consultation.

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At Oread Wealth Partners, helping clients align their finances with what’s important in their life is where we’re always looking to add value . We work with you to determine what opportunities may exist to mitigate taxes, plan around investing, make sure your estate plan is in order & that you’re protecting yourself from liability where possible. We help you to actually take action in implementing various strategies that may be available. If implementing these types of strategies seems daunting, consider subscribing to our newsletter or reaching out for a consultation today on how we can partner with you to align your finances with what’s important in your life.

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