Have any searchers had issues with a 338(h) election?

searcher profile

April 23, 2024

by a searcher from Duke University in West Palm Beach, FL, USA

I spoke to a self-funded searcher yesterday who's having difficulty getting a 338(h) election done for several reasons:

1) His attorney wasn't familiar with the F-reorg process and didn't inform him that he would need to have an entity set up to acquire the target,

2) His CPA also wasn't familiar with the process, and

3) He is near the SBA DSCR limit and so is having difficulty coming up with the extra money that the seller wants to cover the increased tax liabilities caused by a 338(h).

Has anyone else faced similar issues or are these uncommon problems?

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Reply by a searcher
from University of Pennsylvania in Seattle, WA, USA
I have had similar experiences as James describes. For some reason talking about an asset sale is fine but talking about a stock sale taxed as an asset sale creates discomfort and all of a sudden sellers want something for agreeing. I had so many negative experiences that I stopped bringing it up and closed my transaction as an asset sale. Wonder if the seller is open to the negotiated price as an asset sale. Most (don't have good number) of small businesses are sold as asset sales so it may be helpful to walk through that this is equivalent to an asset sale and the multiples the offer is based on come from asset sale multiples.

Definitely concerning that this is uncharted territory for the deal team if it is too late to transition to a new team.

The business school answer is generally to find the most tax efficient structure for the deal and then share in the benefit across all parties, trying to capture as much as possible yourself, but that can be tough to talk through with sellers and sometimes keeping it as simple as possible is best.

I think one way you can approach with the seller is that in a post TCJA world, there is so much accelerated depreciation that it is not 'fair' to have zero tax basis for the assets you are buying. I have had that approach be received more favorably and can be helpful to the conversation.

I had this bust a couple deals so I feel for you. Good luck!
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Reply by a professional
from University of Michigan in Detroit, MI, USA
Hi ^redacted‌, as others have noted, a 338 election and f-reorg are not the same thing. A 338 election is not the norm, but we certainly come across it in search deals (and its cousin the 336 election). From a corporate law standpoint, they're not complex. But your searcher should make sure to retain a tax profession who understands what they are doing to execute.

As for the purchase price game, yes, tax is often zero sum. But, from a negotiating standpoint, your searcher should push back against the seller's demands. The reason you need to do a 338 is because of the nature of the business. In other words, the seller is not doing your searcher a favor; the seller is going to have the same problem with other buyers. At the very least, the seller should compromise, especially given issue number (3).

Let me know if I can help in any way. Always happy to discuss.
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