A Sleeping Tax Technique Comes to Life

September 1, 2013

By Thomas W. Garton and Matthew L. Stortz

A new tax tool has been added to our transaction tool kit. It may prove useful in certain bank transactions where the acquired bank (or holding company) is an S Corporation. These new rules have been languishing in the wings since their addition to the Internal Revenue Code in 1986. Twenty-two years later, in 2008, Proposed Regulations provided a preview of the intended scope and detail of the provisions. The Proposed Regulations were finalized on May 15, 2013, and 27 years after Congress acted, the Code provisions have now become applicable. The Code Section was not self-executing and was therefore unusable until final regulations were adopted.

This legislative journey originated with the adoption of Code Section 336(e) which empowered the Treasury to adopt regulations to permit essentially the same tax outcome achievable through a Section 338(h)(10) election. However, unlike Section 338(h)(10), Section 336(e) does not require the purchaser of the stock to be a single corporation.

Transaction planners have become familiar with the Section 338(h)(10) election which allows parties to certain stock purchase transactions to elect to treat the transaction for tax purposes as an asset purchase. In the case of the sale of S Corporation banks (or S Corporation bank holding companies with Qualified Subchapter S Subsidiary banks), corporate purchasers can gain the tax advantage of a step up in the tax basis of bank assets, including goodwill, without significantly increasing the single-tax consequences that the selling shareholders would report on a stock sale without the election. With some exceptions, this creates a win-win situation for the purchaser and the seller.

However, there are limitations on the use of the familiar Section 338(h)(10) election. There must be a single purchaser of the stock; the purchaser must be a corporation; and the purchaser must purchase 100% of the stock of the target company. If the purchaser is an individual or group of individuals, the Section 338(h)(10) election is not available. A common “work-around” to comply with the single corporate purchaser requirement is achieved by having the purchasing individual or individuals form a new corporation which becomes the actual “purchaser” of the target company stock, thus meeting the single corporate purchaser requirement. Through the use of state law merger statutes, this new acquisition entity, which has no operational function except to comply with Section 338(h)(10), could be eliminated as part of the transaction, leaving the purchasing group individuals as shareholders of the acquired holding company or bank.

Taxpayer pressure to finalize the Section 336(e) provisions was likely blunted because of this effective, if somewhat complicating, mechanism for meeting the single corporate purchaser requirement of Section 338. Now that Section 336(e) is operable, some transactions will be able to be completed without the need to form a new corporate purchaser. Further, a purchase of no less than 80% of the target company stock will qualify for the new Section 336(e) election rather than the 100% requirement of Section 338(h)(10).

The following chart summarizes key differences between Section 338(h)(10) and
Section 336(e):

Section 338(h)(10) vs.

Section 336(e)

  • Acquirer must be a corporation

  • Applies only to sales

  • Generally, single acquirer required

  • Seller and acquirer elect jointly

  • Election due on the 15th day of the 9th month following the disposition

  • Acquirer need not be a corporation

  • Applies to sales, exchanges, and distributions

  • Multiple acquirers allowed

  • Seller elects unilaterally

  • Election due when reporting party’s tax return is due

It is yet to be seen whether the Section 336(e) election will find wide acceptance in the transaction community. The benefit of purchasing only 80% of the target stock may prove useful. The new election may also become popular as a means of eliminating the need for the creation of a new acquisition corporation in order to qualify for the Section 338(h)(10) election. Whether it is widely embraced or not, it is nonetheless an important specialized tool to keep in mind where the purchase of the stock of an S Corporation is contemplated and where the value of the corporation’s assets exceeds the corporation’s tax basis.


Potential sellers and buyers of S Corporation banks or bank holding companies now have more flexibility in structuring their acquisitions, allowing asset purchase treatment to apply in stock acquisition transactions.