Alvarez & Marsal Flags Potential State Tax Surprises in IRC Section 338(h)(10) Elections
Alvarez & Marsal highlights that electing IRC Section 338(h)(10) in U.S. business acquisitions can lead to unexpected state tax liabilities if not carefully managed. The consulting firm urges buyers and sellers to understand these varying state rules.
Consulting firm Alvarez & Marsal is alerting businesses to potential unforeseen state tax consequences arising from elections under Internal Revenue Code (IRC) Section 338(h)(10) during corporate acquisitions. The firm emphasizes that while these elections typically offer federal tax benefits, they can create significant state tax liabilities if state-specific rules are overlooked.
The IRC Section 338(h)(10) election treats a stock sale as a deemed asset sale for tax purposes, a mechanism often used to provide buyers with a stepped-up basis in assets. However, Alvarez & Marsal points out that many states do not fully conform to federal treatment, leading to complexities in how gains are classified and apportioned. This disparity can put parties in unfavorable negotiation positions if not addressed proactively.
While most states align with federal tax treatment, several deviate, presenting unique challenges. For instance, California and Wisconsin permit state-level elections independently of federal ones. Furthermore, the classification of gains—whether as business income subject to apportionment or nonbusiness income allocated to a specific state or domicile—varies significantly among jurisdictions.
Alvarez & Marsal advises both buyers and sellers to thoroughly examine each state's specific regulations regarding conformity, gain classification, and apportionment formulas. Understanding these nuances is crucial for accurately assessing the overall tax cost and benefit of making a Section 338(h)(10) election and for ensuring appropriate compensation between parties.