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Foreign. Hello and welcome to the 45th episode of How Tax Works. I'm Matt Foreman. In this episode I'll discuss stock sales taxed as asset sales, talking about every org selling wholly owned subsidiaries 338G, 338H10 and 336E elections. How tax works is meant for informational and entertainment purposes only. This may be attorney advertising and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make. You know, I've said that so many times, so many times, and I stumble on it about, I don't know, one out of five, one out of 10. So we're just gonna let that one roll right before we get started. Administrative things, you know, New episodes in two weeks. The next episode will discuss economic substance doctrine and the step transaction doctrine, most likely assuming I get to recording it. The important thing is the context of that is I'm going to talk about it in a lot of what I'm going to call tax focused investments and cryptocurrency wash sale rules and why they do exist even though they're not securities for income tax purposes. And I think it's really important because I get this question a lot and the answers that they get, the taxpayer friendly answers they get are often general misunderstandings of how tax works, haha. But also a cursory understanding of the underpinnings of what's trying to be done here. And I think it's really important from an income tax perspective to sort of set out why it's wrong, like why people's understanding and what they're trying to do is wrong. So I think that that's really an important point. All right, anyway, so we're talking about, you know, stock sales taxes, asset sales. This is, this is a topic if you ever see me do this in a webinar. This is one that I enjoy doing a lot. But also this is one that make, when I talk through like how stuff works, clients will be like, oh, Matt, you are a genius. How did you know how to do this? And I got to tell you, this is, this is literally just like knowing how to use the machinery at the shop. There is nothing that I'm doing here that I view as particularly noteworthy or impressive. I view this as just core tax structuring, that if you do enough, you just get used to it. You learn what the tools do and you go, all right, I got this, right? So this is kind of how I do it. Before you do any tax structuring, before you do any sale there, there's two rules that I always tell you. One, only pay tax when you're getting cash. And to make sure your clients know when they're going to pay tax and roughly how much, right? If you tell them you have to pay 105,000 and they have to be 106, they won't care. If you told me to pay 105,000, they have to pay 217, they are going to be very displeased with you. Politely but. Well, maybe not politely, but very displeased. I always tell people, check, double double check, and be certain poor communication leads to angry clients. So I strongly, politely but strongly recommend you have that conversation. Sometimes you should lean into taxable transactions. If you're selling stock, you get capital gains, you know, and you could also have, as I talked about a number of times now, qualified small business Stock under under 1202, section 12 to the code. It's a taxable transaction, but you might not pay tax, right? So that's really important to note. So, you know, people always say, oh, what about taxable? Why? So you want tax free? You want tax free? I'm like, well, maybe, right? It depends. Rate can really matter or not matter. Or if you're selling assets, right. The buyer will often pay more because there's depreciation or amortization. There's often there can be a higher net for seller. Especially now, right? 199CAP A&PASS through entity taxes. Boy, I got to tell you, I think selling assets is actually better than selling stock a lot of times because of the ptets. Not going to go into that. Discuss a little bit here, but not really. Whenever you do it, I always say, you know, generally form controls tax. So watch out for entities that have or had a lot of real estate and where the seller or buyer is foreign, there's transfer tax rules. Firpta other withholding can be really important. And when you sell, you know, equity, there can be some real benefits, right? Tax once, generally, capital gains, like I said, potential for QSBs, fewer approvals, no retitling of assets. Right? If you've ever sold like the assets of a car dealership as opposed to the equity, like, that's awful. You know, they own title to 300 cars, 500 cars, a thousand cars, I don't know. Making up numbers at this point, seven cars, who cares? It's annoying. It's work. If you're a lawyer, you'll like it. If you're a lawyer who doesn't feel like sitting there doing the most boring thing. Actually that might be a topic, a task for AI, but neither here nor there, right? But if you're buying the equity, generally speaking, no additional depreciation but you get it and you get a carryover tax attributes, which might not be great, but you know, if you're not retitling assets, you, you know, the question I always get is, well, what if we could do it right? What if we get the corporate benefits of selling equity, which is the carryover tax. There will sometimes carry over tax attributes, but no need to retitle, no need to rename things, but we get the the tax benefits of the step up in basis, right? We're already a pass through QSDS isn't an option. What can we do right in this I'm only going to be talking about corporate stuff. If you sell a LLC or any, you know, LLC that's disregarded entity, or an LLC or any partnership that's tax to partnership, you can get either through Revenue Ruling 995, 996 and Section 754 Elections, you can get a step up in basis by selling the equity. Partnerships are much better and more flexible, especially in that regard. And so that's important. This, this episode is only really going to talk about corporate entities so that I'm also going to really aggressively lead into S Corps, but not entirely. I'll talk about a C corpse a little bit. I always sort of assume that most people have C Corps are just never going to sell the assets and if they do, they're hemmed into being a C Corp because of foreign investors or they're a public company. And if you're a public company listening to my podcast and welcome. I guess that's kind of confusing. Anyway, so pre sale every organizations, right? What is an f re.org? if you're listening to this and this is your first episode, go back. I don't know what episode it is, but there's one called what the F is an f re.org and I talk about what the F is in every right and is a mere change in form, however affected, however effectuated, whatever the word is. And it can be a variety of things. Changing a corporation's name, change in the form of corporations such as an Inc to a corp. Business trust to a state law corp, LLC to a state law Corp. As long as they're all taxed as corporations, right? F Reorg is a pure tax thing. 368A1 cap F of the Internal Revenue Code. You can use them to change the corporation state of incorporation. So move it from state A to state B company. Use it to convert from like a mutual savings and loan association to a stock savings and loan association. And with the most common f reorg at least the ones that I deal with are used to basically drop a new entity below the S corp so that it's an llc. You can use a tax as a partnership and do it as a mechanism to have a part sale, part rollover. That is by far the most common f reorg that when people are talking about every orgs they do. I actually think there are more f reorgs than exist otherwise because they are used for other things. But that's the big one. Whenever we talk about pre sale f reworks there's slides on this that I'm not going to post. But basically what you mechanically have to think through, you have an S corp with one or two or six shareholders. At the start it's just the opco and by the end of it you're going to have a hold co which is going to be an S corp and it's going to own the opco. And the opco is now a subsidiary and it's either a S corp that is a qualified subjector subsidiary or Q sub or it is an OPCO that is either converted statutorily or there's been a merger. So the OPCO is now an LLC with a single owner. So it's a disregarded entity as a single owner, single member llc. That's, that's the f re Org we're talking about. That's the end result. And when you sell a wholly owned subsidiary, when an S Corp sells either the Q sub or the disregarded entity that's an llc, it is taxed as an asset sale. And that's really important, right, because all you've done is a basic restructuring. But you've gone from having an S Corp which you can do the asset sale but there's different ways and you do it. People always ask well if you're going to sell 100%, why would you do that? The answer is I've had a couple times. We have one company that has two separate businesses or distinct lines of businesses. And so you can mechanically, you basically do the f re Org then you distribute one of the business, the one you're holding from the subsidiary up to the parent. That's tax free, okay? Then you sell the one Entity that exists that. That's held underneath, that's still in there. That's an asset sale. And that's why you've done it. I've done it a few times. You can also do, you know, I always say a. A stock sale. Escorps could hold C Corps, S Corps, you know, can do that. And that's really important. That's still a stock sale. You can do asset sales. If you have a C corp that holds a llc, that's disregarded. Obviously C Corps can hold S Corps. They are dis. They are ineligible shareholders. So they're not allowed. And if you, you know, I've seen it where they have a C corp that holds another C Corp. They own a couple. They're trying to sell the subsidiary. Like, well, how can we get this stuff up in basis? What can we do? What's this? This, what's that? And I always point out that that's Gregory, that's a stock sale. Trying to sell it as an asset sale might not really be what you're looking for. So there's other ways to do it. Gregory is a fairly famous case. Talked about it in a prior one. I reference it every so often. Never a good sign when the, when there's an audit and the IRS starts by saying, you know, could you describe how this is different from Gregory? I've never had that happen, but I suspect that it would be an unpleasant position to be in from an advisor standpoint. So let's talk about, you know, we've talked about F3 Orgs, we've talked about sales of Q subs and disregarded entities. But you know what? Before, before I actually get to that, let's, let's take a quick music break and we'll come back for 338G, 338H10 and 336E11. Okay, so let's, let's come back now. We're going to talk about stock sales treated as asset sales under the various elections. Right. This is a situation where form does not control the tax. As a general rule. The, the three different ones you can do. There's a 338 election, which the election is actually made under 338G. There's an election, the 338H10 election and 336E. Every so often I have people, they're like, oh, we're going to do a 338election. And then I have to sort of do the uncomfortable thing of like, well, which, which one? And they're like, oh, the 338. And I'm like, there's two of them. You know, they almost always mean 338H10. 336E is really the same as a 338H10 to different buyer. As a general rule, you must sell at least 80% of the business. You can creep to 80%, you just need control. Under 368C, it's taxed as if you sold 100%. So if you only buy 80 and you make a 3, you make any of these elections. It is taxed if you sold 100. So the seller needs to be aware of this. The buyer won't care, but the seller be very interested. And it is an alternative to an F reorg for a taxi rollover. I have never seen one of these where less than 100% was sold. And I've seen them discussed where they're 99, 98%. I've had ones that I think ended up being them, but they didn't hire me. Where There was a 95% and it was a small enough number where they made the decision that that's what they're going to do and that's the easier way to do it. But generally people want to be as maximally efficient. So they're going to do an F Re. Org state Specific issues. Some states ignore 330H10 and 336E elections. New Jersey does kind of fascinating for me. Ohio's cat commercial activity tax, actually it ignores these. So you're fine. You don't trigger the cat by doing this because it is an income tax and the commercial activity tax is technically not a income tax. Which is interesting. I always say New York City is a party. So New York City ignores the existence of S Corps. Right. So it doesn't. It just imposes a tax at the city level. So what ends up happening is you're taxed at the entity level on these elections. So. So that's a really important thing to do. There are specific rules for related party that are pretty broad. No. 338H10 or 338 which is G or 336E. If you're related, you know the buyer is related to the seller. So watch out for that. However, if you do an F reorg and sell a Q sub that is still get asset sale treatment, you don't trigger 1239 because 1239 has different related party rules than the related party rules under 336E.338 and I think that's really Important. You know, I think it's really important that you know that sometimes you can do the same thing two different ways and you do it in a way that will give you the favorable tax treatment. You know, this is Gregory. Right? You don't have to pay more in tax. You just can't structure in a way that makes no sense to get there. So for the 338election which is 338G form does not control the tax. The actual step is the seller sells the stock of the subsidiary to the purchaser. Right? Right. The pretend step is that the target then after the sale. Right. The target then sells its assets to an unrelated person. Then the new target purchase all the assets back. Right. Why would you do this? It sounds really daffy. Why would you sell it? Then the buyer is like oh, I want to. I want to trigger some gain here. And the answer is it's easier to document than an actual sale and you don't need to get certain approvals. And then for tax reasons the tax implications of an asset sale. So you want that what are the tax implications? Right. So you cannot. First off, it's something you can't do. You can't offset the purchaser's gains with attack with the target's losses. 338H9 says no. But you can offset the target losses with the targets gain from the 338G election. So if it's having an atrocious year and you sell it, that's a way to actually trigger it. You can use NOLs. Obviously there's the 80% limitation but that's something you can actually do. So the target post sale. So the acquirer through the target. Right. Bears the brunt of the taxes within at the end of the level. But it does get the step up. So that. That's one way to think about it and it is a fairly viable option. The next One is the H10 election. 338. 10 the actual step is the acquirer purchases at least 80% of the vote or value of the target stock from the seller. The pretend step starts coming in. The target is deemed to have you so you ignore the purchase. Okay. You ignore the actual step altogether. Whereas in 338 you normally it actually happens. 338h10 it does not happen. The target is deemed to have sold all its assets for cash while it's in the old Consolidated Group. 1.338 10 1D. The target is treated as if it is liquidated. Cash goes to the seller. 338H10 1D as well. The seller inherits the tax liability. The seller's basis in the stock, new stock is disappears. Then the acquirer creates a new corp. Has the same ein. Same name as the target, as the acquired company. What a shocker. And then it purchases the assets from the unrelated person with the. You know that. And so what happens is effectively by creating that roundabout step, the target has a fair market value basis on its assets and the acquirer has cost basis in the target stock. I know I talked about how you know it's in the old consolidated group and all that. You can with an S Corp sell these, sell the stock directly. You don't actually need a consolidated group or a parent for an S Corp to undertake a 338H10 a transaction through 3810 election. That's really important to note to C Corp. You do need a consolidated group because you do need to impose corporate tax in a certain way. Then we're going to talk about 336e. 336e is really interesting because it's the same thing as 33810 except the buyer does not have to be a corporation. I always leave this out in the first part H10 elections. The buyer must be a corporation. CRS doesn't matter. In A336E the acquirer cannot be a CRS Corp. And I think this is really important is if you have a situation where the parent is acquires a C Corp and the subsidiary is a disregarded entity taxes and tax or an LLC taxes discovery disregarded entity that is still the C Corp buying it. You have to do the H10. However, if you just have an individual buying it, you have a partnership buying it. That's you're doing 336e same steps, same everything as 336 as 338h10. Couple little wiggles, couple little wrinkles, but same basic idea. I'm not going to go into it. The reason people do this one in particular is after the sale they take that corporation and with the new step up basis and they just convert it to an llc. Tax is a partnership tax disregarded entity. They merge to make it whatever. And the idea is it's a way to get out of the S Corp or C Corp structure. Pretty common. People are like how did I not know this existed? And they're like well when was it made into law? And I said well the law was actually part of the general utilities appeal as a part of the Tax Reform act of 1986. And they're like, but I've never done one before. And I'll say, yeah. So what happened is the code did not do anything by its own terms. The Internal Revenue code said that 336e is not operative until there are finalized regulations. They were not proposed until 2008. So 22 years later and then finalized in 2013. So five years after that, 27 years. Okay. You are done with college and medical school by then and you are halfway through your residency. Okay. By the time they did it. Pretty, pretty incredible. And I think that's really important to note how long it took. You know, it's really similar to every org than selling a disregarded entity, but no need to retunnel the assets. And I think it's really important to note who can do it. And this is like a hammer home. H10 acquirer has to be a corp. CRS 336E acquire cannot. One word. Cannot. Not allowed to be a CRS corp. And I think that's really important. All right, we're going to get a little more music and then I'm going to bring it home with a couple kind of best practices and sort of some ancillary comments that I think tie this all together. Okay, so. So we're going to bring it home with stock sales treated as asset sales. So just this sort of the other concerns department, tying it all together. The character of the gains is whatever it would be if you were just to sell it. If you were to do like an earn out. For example, under Aerosmith v. Commissioner, 344 U.S. 6, the earn out retains the same character as when you sold it. So it doesn't all become capital or it doesn't all become ordinary. It's the same ratio. Ordinary income, sales, bonus, stuff like that. That's important. I always tell people with, with installment sales under 453, watch out for 453 Cap A. If you have a large enough amount that's owed. I think that's really important. The parties need to agree and then don't go rogue like in Danielson. 378 F.2d 771, third circuit decision. But you know, it exists in every circuit. That's why there has not been any Supreme Court case because the Third Circuit actually got it right and basically one party decided, you know, we don't like this, we're going to make a capital. And yeah, 3rd Circuit said no. IRS said no. 3rd Circuit agreed with the IRS. I always tell people, watch out for golden parachutes. Under 280g because you could have a. You know, people always say, well what happens? Oh, we have an S corp, we have an S Corp. And as anyone who deals with S Corp knows that it's, it's really easy to blow the S election. So if you've accidentally blown the S election, you may have a golden parachute if you have to give a deal bonus. Right. The most interesting, and I talked about this in my episode about golden parachutes is that there is no golden parachute which is a significant tax. If it could have been an S corp at the time, but it wasn't for a variety of reasons. So if you just happen below the selection, but let's just say that you had an ineligible shareholder and then they left, then you sold, then you don't have a golden parachute problem because it could have been an S corp at the time even if it wasn't. And I think that's really important. Other benefits to talk about. There's no wells and deductions. So NOLs versus suspended losses. Always point out to people that suspended losses are usable immediately in full with no restrictions. Whereas NOLs have a rule where they can only offset up to 80% of your income. So NOLs are slower and suspended losses. So if you have losses and you want to use it, do analysis, see if they're actually suspended losses, you know, passive activity at risk rules, things like that. Because that actually can be tax beneficial. I have run into that situation. Something you want to think about. Carryover nols and credits. There are limitations. If you buy it, you know, if you're doing a C corp and you're selling the stock, it's important to know, you know, can you actually use the NOLs in lost corporations or use the carry forward credits? The answer is often no, you really can't. And so it's important to make sure you understand the math of that. You know, there's business expenses between the parties like when the expenses happen. If there's a buyer and a seller and they're totally different. Right. If you just buy the stock of a C corp kind of cranks itself, keeps going along. But if you buy the stock of a C corp and you do a 338 HTET election, for example, it's two separate returns altogether. It's totally separate. And for an S Corp that can be important too. So it's really important to do it. Drafting best practices, be clear, discuss early and often. Give slide decks as to what's going on. I don't think it's possible to slip this in without someone noticing who's paying attention and knows what they're doing. It is theoretically possible to slip this in if people don't know what they're doing, don't have proper tax counsel or a proper tax advisor. Generally talk to accountants, make sure they know what to do, how this is done, what's it's important. And you know, look, the lead here, the most important thing is talk to your clients, explain to them what's going on, explain what they have to do. People always ask me, you know, are these going to change? This going to this, this and that. And I don't know, I mean it hasn't changed. I don't see this as a big issue. So I don't really see how this would change. It is possible that states could couple decouple, whatever. You know, New Jersey is obviously out in certain ways, but it's really important. You know what I always point out to people is a 336e338 10 election can actually be much more efficient for pass through entities due to the PTETs, state local tax, the deduction cap. I know they raised it but for a really high income earner, half a million dollars, $600,000 is not a huge amount of income, especially when you're selling a business in a year. So the PTF becomes really important and I think it's really important. And anyone who says, and I always talk that, say this whenever, talk about legislative or possible potential legislative changes is anyone who says they know what's going to happen is either lying or stupid or perhaps both. Always, always a great thing. I think it's really important to say that look like yes, asset sales do get generally get higher purchase prices. Not necessarily. The seller may also look at it and say well I don't really want to deal with everything that I have to deal with if I do this. So maybe I'll just buy the stock and call it a day. Or they can get it at a discount. Because look, especially, especially QSBs, right? If, if the seller's getting QSBs they are totally fine with a 30 cut or 20 cut or whatever because they're paying no tax, right? So you look at, you know, look, the corporate tax rates are 21 plus whatever the state is effective rate 25%. You're going to slide that over you know, 15 years for amortization, right? So like the time value of money might be only like an 8 or 10% drop off in purchase price. So something the assets may be worse, maybe better you might actually get more, especially with ptets. Right. You sell stock. There's no ptet because you're selling stock. So, you know, it depends, right? It depends. And it can be really important. So I think it's really important to make sure, you know, you're controlling the the type of entity it is, how it's taxed, what it is. Model it out, have the discussion, you know, definitely talk to your clients. All right. That was the 45th episode of How Tax Works. Hope you enjoyed it. Hope you learned something. I'll be back in two weeks with the 46th episode and where I'm going to talk about the economic substance doctrine and SEP transaction doctrine in the context of, I'll just say, people's general misunderstandings of how tax functions. Now for the best song of all time. Hope you enjoy. Sam. Sa.