LA Deal Maker or Breaker: The §338(h)(10) Election in Business Purchase and Sale

When negotiating the sale of a business in Los Angeles, California, one tax strategy often determines whether a deal succeeds or fails: the Section 338(h)(10) election. This powerful tax provision bridges the gap between buyer and seller priorities:

• Buyers want tax deductions and a stepped-up basis.
• Sellers want to minimize taxes and maximize after-tax proceeds.

With over 20 years of dedicated M&A experience, the attorneys at Simantob Law Group specialize in modeling and negotiating this election, turning a complex tax rule into millions in added value for our Southern California clients.

Most Los Angeles business sales involve S Corporations or subsidiaries holding valuable assets like real estate, technology, and proprietary client lists.

 

In a stock sale, the seller benefits from lower capital gains tax, but the buyer inherits the company’s existing tax basis, limiting future deductions. In an asset sale, the buyer gains a stepped-up basis for depreciation and amortization, but the seller faces higher ordinary income tax. The §338(h)(10) election combines the best of both worlds: it preserves the legal simplicity of a stock sale while granting the buyer asset-sale tax benefits. To balance the seller’s increased tax burden, a negotiated tax gross-up ensures they receive their intended after-tax proceeds.

Feature	Stock Sale	Asset Sale	§338(h)(10) Election
Legal Form	Simple Stock Transfer	Complex Asset Assignment	Stock Transfer (Legal Simplicity)
Buyer’s Tax Basis	Low, Inherited Basis	High, Stepped-Up Basis	High, Stepped-Up Basis (Buyer Win)
Seller’s Tax Rate	Lower Capital Gains	Higher Ordinary Income	Higher Ordinary Income
Seller’s After-Tax Proceeds	Standard Price	Reduced Net Proceeds	Standard Net Proceeds (via Gross-up)
Primary Driver	Seller Preference	Buyer Preference	Tax Optimization (Win-Win)

The §338(h)(10) election solves this by:

• Legally executing a stock sale (preserving contracts, permits, and continuity—critical in LA’s competitive and regulated environment).
• Treating it as an asset sale for tax purposes.

Result: Buyer gets tax benefits of an asset sale; Seller is compensated through a tax gross-up in the purchase price.

 

Our two decades of experience have shown that a successful §338(h)(10) election hinges on calculating two crucial, but different, formulas:

The ADSP is the final price the Old Target company is deemed to have sold its assets for. It determines the seller’s tax liability.

ADSP=Purchase Price+Assumed Liabilities+Tax on Sale

This formula is circular because the tax owed is based on the ADSP, which itself includes the tax! This requires specialized algebraic modeling to solve for the final, correct tax liability.

2. Buyer’s Tax Benefit: Adjusted Grossed-Up Basis (AGUB) (H3)

The AGUB is the total new tax value the buyer can assign to the assets for future deductions.

AGUB=Purchase Price+Assumed Liabilities

Allocation to Goodwill (The Buyer’s Jackpot) (H3)

The AGUB is allocated to the acquired assets using a mandated sequence. The most desirable outcome for the buyer is a large residual amount allocated to Goodwill, which is fully amortizable (written off) over 15 years.

Allocation Class	Asset Type
Class V	Tangible Assets (Equipment, Real Estate)
Class VI	Specific Intangibles (Patents, Customer Lists)
Class VII	Goodwill (The Residual)

Numeric Example: How the Step-Up Creates Value

Assume the AGUB (Buyer’s New Basis) is $12,000,000, and the Old Target’s tax value (Inside Basis) was only $3,000,000. This creates a $9,000,000 tax basis step-up.

• Buyer’s Tax Benefit:
  • The AGUB is allocated, resulting in $6,000,000 assigned to Goodwill.
  • This creates a $400,000 annual deduction ($6,000,000 ÷ 15) for the buyer for 15 years.
  • The Present Value (PV) of these tax savings often amounts to over $1,000,000, justifying the gross-up payment to the seller.
• Seller’s Tax Impact:
  • The seller’s immediate tax bill is higher due to the ADSP.

The Solution: Simantob Law Group negotiates a tax gross-up so the buyer pays a bonus that precisely offsets this increased tax, ensuring the seller nets their intended after-tax proceeds.

Before you sign the Letter of Intent (LOI), schedule a consultation with our experienced M&A tax attorneys.

The negotiation of the §338(h)(10) election—and the crucial tax gross-up—must happen early. Our modeling ensures you secure maximum after-tax proceeds and avoid costly surprises.

Call us at 338.281.0041 to discuss how to structure your Los Angeles business sale.

For the sale of a business in Los Angeles, California, the election is complicated by the Franchise Tax Board (FTB). Our over 20 years of M&A experience in California is critical here.

Apportionment Risk 

While the FTB generally respects the federal election, their rules for apportioning (dividing) the deemed sale gain can create unexpected tax bills for multi-state businesses. The FTB’s rules can exclude the large sale receipts from the sales factor, potentially causing a disproportionately higher percentage of the gain to be taxed in California.

Our Expert Strategy 

We draw on decades of experience to model these complex state tax scenarios and negotiate full tax gross-up provisions that shield our clients from the incremental federal and California tax hit resulting from the election, ensuring our clients receive maximum net proceeds.

Q. What is a §338(h)(10) election?

The §338(h)(10) election is a tax strategy that allows a stock sale to be treated as an asset sale for tax purposes. This gives the buyer a stepped-up basis in the acquired assets while preserving the legal benefits of a stock sale.

Q. Why is the §338(h)(10) election important in business sales?

It resolves the common conflict between buyers and sellers: Buyers want tax deductions, and Sellers want maximum after-tax proceeds. The election creates a win-win scenario when properly negotiated.

Q. How does the election affect California taxes?

California’s Franchise Tax Board (FTB) generally respects the federal election, but its apportionment rules can increase state tax liability for multi-state businesses. Proper planning and negotiation are essential to avoid unexpected tax bills.

Q. What is a tax gross-up and why is it needed?

A tax gross-up is an additional payment from the buyer to the seller to offset the seller’s increased tax liability caused by the election. Without it, the seller could end up with less than their intended net proceeds.

Q. Who should consider a §338(h)(10) election?

Business owners selling S Corporations or subsidiaries in Los Angeles—or anywhere in California—should consider this election, especially when the buyer values tax deductions and the seller wants to maximize after-tax proceeds.

Q. How can Simantob Law Group help?

We model the tax impact, negotiate gross-up provisions, and ensure compliance with IRS and California FTB rules. Our goal is to structure your transaction for maximum financial advantage.

If you’re buying or selling a business in Los Angeles, the §338(h)(10) election can make or break your deal. With over 20 years of M&A expertise, we model the tax impact, negotiate gross-up provisions, and ensure compliance with IRS and California FTB rules.

Do not risk an audit or an unnecessary tax bill.

Complete our online contact form today to schedule your consultation regarding the §338(h)(10) election and let us help you secure your negotiated gross-up.

Simantob Law Group is a law firm of business attorneys and real estate lawyers in Los Angeles. We have represented the business and real estate legal needs of individuals and companies, from start-ups to regional and national US corporations for over 20 years.

Please contact us at (310) 281-0041 or complete our online contact form to discuss your §338(h)(10) election with a Los Angeles Business Attorney.

This blog post is for informational purposes only and does not constitute legal, tax, or financial advice. Reading this article does not create an attorney-client relationship. For advice specific to your situation, please consult a qualified professional.