Understanding 338(h)(10) Elections in M&A Deals
If you spend enough time in M&A, you’ll eventually hear about something called a 338(h)(10) election.
For many founders, it sounds like technical tax jargon.
And at first glance, it is.
But beneath that complexity is something incredibly important:
A way to bridge the gap between what buyers want and what sellers want—especially when it comes to taxes and deal structure.
Because in most transactions, there’s a natural tension.
Buyers prefer asset deals.
Sellers prefer stock deals.
A 338(h)(10) election is one of the few tools that can align those interests.
But only if you understand how it works.
The Problem It Solves
Let’s start with the core issue.
In a traditional structure:
- Stock sale → Better for sellers (capital gains treatment, cleaner exit)
- Asset sale → Better for buyers (step-up in basis, reduced liability exposure)
This creates friction.
Buyers want one thing. Sellers want another.
And negotiations often stall around this exact point.
A 338(h)(10) election is designed to solve that problem.
It allows a transaction to be treated as:
- A stock sale legally
- An asset sale for tax purposes
That dual treatment is what makes it powerful.
How a 338(h)(10) Election Works
At a high level, here’s what happens:
The buyer purchases the stock of the company.
But both parties jointly elect—under Section 338(h)(10)—to treat the transaction as if the company sold its assets and then liquidated.
So:
- From a legal standpoint, ownership transfers through stock
- From a tax standpoint, it’s treated like an asset sale
This allows the buyer to achieve a step-up in asset basis, which creates future tax benefits.
At the same time, the seller can often structure the deal in a way that remains more favorable than a traditional asset sale—depending on the entity type.
When a 338(h)(10) Election Is Available
This election isn’t available for every deal.
It’s typically limited to:
- S-corporations
- Certain subsidiaries of C-corporations
If you’re operating as an LLC or partnership, this structure generally doesn’t apply.
And for standalone C-corporations, other considerations—like double taxation—come into play.
This is why understanding your entity structure early is critical.
Because not every option is available in every situation.
Why Buyers Like It
From a buyer’s perspective, the benefits are clear.
The biggest advantage is the step-up in asset basis.
This allows the buyer to:
- Depreciate or amortize assets going forward
- Reduce taxable income in future years
- Improve overall return on investment
In a traditional stock sale, buyers don’t get this benefit.
So a 338(h)(10) election gives them the tax advantages of an asset deal—without requiring a full asset purchase.
That’s a compelling outcome.
Why Sellers Might Agree to It
At first glance, a 338(h)(10) election may seem like it primarily benefits the buyer.
And in many ways, it does.
But sellers can benefit as well—especially when it’s used as a negotiation tool.
For example:
- Sellers may negotiate a higher purchase price in exchange for agreeing to the election
- Certain tax outcomes may still be more favorable than a direct asset sale
- It can make the deal more attractive to buyers, increasing competition
The key is understanding the trade-offs.
Because agreeing to a 338(h)(10) election without evaluating the tax impact can lead to unintended consequences.
The Tax Impact for Sellers
This is where things get more nuanced.
Because while the structure is legal stock sale, the tax treatment resembles an asset sale.
That means:
- Some proceeds may be taxed as capital gains
- Some may be taxed as ordinary income
- Depreciation recapture may apply
The exact outcome depends on:
- The company’s asset composition
- Prior depreciation
- Purchase price allocation
For S-corporations, the impact is often manageable.
For C-corporations, it can be more complex—particularly if double taxation becomes a factor.
This is why detailed modeling is essential before agreeing to this structure.
Purchase Price Allocation Still Matters
Even with a 338(h)(10) election, allocation plays a critical role.
The purchase price is divided across asset categories, such as:
- Goodwill
- Tangible assets
- Inventory
- Non-compete agreements
Each category has different tax treatment.
So while the election changes the structure, it doesn’t eliminate the importance of allocation.
In fact, it often makes it more important.
Because both parties are now highly focused on how value is assigned.
A Negotiation Tool—Not Just a Tax Election
One of the biggest misconceptions about 338(h)(10) elections is that they’re purely technical.
They’re not.
They’re strategic.
They’re often used as a lever in negotiations.
For example:
- Buyer wants step-up in basis → pushes for election
- Seller evaluates tax impact → requests price adjustment
This creates a trade-off.
And that trade-off becomes part of the deal dynamics.
On the Legacy Advisors Podcast (https://legacyadvisors.io/podcast), we’ve discussed how deal structure often becomes a negotiation tool—not just a legal decision.
This is a perfect example of that.
When It Makes Sense
A 338(h)(10) election tends to make sense when:
- The buyer strongly values the step-up in basis
- The seller can manage the tax impact
- Both parties are willing to negotiate around structure
- The entity type allows for the election
It’s not always the default choice.
But in the right situation, it can create alignment where there would otherwise be conflict.
Common Mistakes to Avoid
Like many advanced structures, the risk isn’t in the concept.
It’s in the execution.
Common mistakes include:
- Not modeling the tax impact in detail
- Assuming the election is always beneficial
- Failing to negotiate price adjustments
- Overlooking allocation implications
- Engaging advisors too late in the process
This is not a structure you “figure out later.”
It needs to be evaluated early—ideally before an LOI is finalized.
The Role of Advisors
A 338(h)(10) election sits at the intersection of:
- Tax strategy
- Legal structuring
- Deal negotiation
That means you need alignment across:
- Tax advisors
- Legal counsel
- M&A advisors
At Legacy Advisors (https://legacyadvisors.io/), we help founders evaluate these structures in the context of the entire deal—not just in isolation.
Because the goal isn’t to optimize one variable.
It’s to optimize the outcome.
The Bigger Picture: Structure Drives Outcome
This is something I emphasize consistently in The Entrepreneur’s Exit Playbook (https://amzn.to/40ppRpT):
Structure matters.
Not just price.
Not just timing.
Structure.
Because it determines:
- How you’re taxed
- How risk is allocated
- How value is realized
A 338(h)(10) election is just one example of that.
But it’s a powerful one.
Final Thoughts
A 338(h)(10) election isn’t something every founder needs.
But it’s something every founder should understand.
Because even if you don’t use it, it may come up in negotiations.
And if it does, you need to know:
- What it means
- How it impacts you
- How to respond
The best founders don’t just react to deal terms.
They understand them.
They evaluate them.
And they negotiate from a position of clarity.
If you’re preparing for a transaction and want to ensure your deal is structured for the best possible outcome, visit https://legacyadvisors.io/
And if you’re looking for a practical, founder-focused framework for navigating M&A, The Entrepreneur’s Exit Playbook is a great resource: https://amzn.to/40ppRpT
Because in the end, the structure of your deal isn’t just technical.
It’s financial.
Frequently Asked Questions About Understanding 338(h)(10) Elections in M&A Deals
What is the main advantage of a 338(h)(10) election for buyers?
The primary advantage for buyers is the ability to receive a step-up in the tax basis of the acquired assets.
In a traditional stock purchase, the buyer inherits the company as-is, including its existing tax basis in assets. That limits future depreciation and amortization opportunities. With a 338(h)(10) election, the transaction is treated as if the company sold its assets, allowing the buyer to reset the value of those assets to the purchase price.
This creates meaningful future tax deductions, which can improve cash flow and overall return on investment.
In many cases, this benefit is so valuable that buyers are willing to pay more—or push harder in negotiations—to secure this structure. That’s where it becomes a strategic lever for sellers as well.
Does a 338(h)(10) election always benefit the seller?
Not necessarily.
While a 338(h)(10) election can help facilitate a deal and even lead to a higher purchase price, it often results in tax treatment similar to an asset sale. That means portions of the proceeds may be taxed as ordinary income rather than capital gains.
For S-corporation shareholders, the impact is often manageable and can still be favorable compared to a direct asset sale. But for C-corporations, the situation can be more complex due to potential double taxation.
The key is not to assume it’s good or bad—it depends on your specific tax profile, entity structure, and deal terms. Sellers should always model the after-tax outcome before agreeing to this election and use it as a negotiation point if it benefits the buyer more than themselves.
How is a 338(h)(10) election different from a regular asset sale?
The key difference lies in how the transaction is treated legally versus for tax purposes.
In a traditional asset sale, the buyer purchases individual assets and liabilities directly from the company. This often requires transferring contracts, retitling assets, and navigating third-party consents.
With a 338(h)(10) election, the buyer purchases the stock of the company, so legally, ownership transfers more cleanly. However, for tax purposes, the transaction is treated as if the company sold its assets.
This hybrid approach combines the simplicity of a stock sale with the tax benefits of an asset sale. It can reduce operational complexity while still achieving many of the same financial outcomes for the buyer.
When should a 338(h)(10) election be discussed during a deal?
Ideally, this should be addressed early—before or during the letter of intent (LOI) stage.
Waiting until late-stage diligence to introduce or evaluate a 338(h)(10) election can create friction and delay the process. By that point, expectations around structure and tax treatment may already be set, making it harder to renegotiate.
Early discussion allows both parties to:
- Model tax outcomes
- Align expectations
- Negotiate trade-offs (such as price adjustments)
This is especially important because the election requires agreement from both buyer and seller. It’s not something one side can impose unilaterally.
Addressing it early keeps the process smoother and preserves leverage on both sides.
Can a 338(h)(10) election be used in all M&A transactions?
No, it’s limited to specific types of entities.
This election is generally available for:
- S-corporations
- Certain subsidiaries of C-corporations
It does not apply to LLCs taxed as partnerships or sole proprietorships.
Because of these limitations, entity structure plays a major role in determining whether this option is even on the table. If your business isn’t structured in a way that qualifies, alternative strategies—such as different deal structures or elections—may need to be considered.
This is another reason why early planning matters. Your entity choice can directly impact what options are available to you when it’s time to sell.