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05.03.17 by Andrew Shafer

Deemed Sales of Stock


 The 1986 Tax Reform Act added a provision that allows a corporation (or all of the stockholders of an S Corporation) selling stock in a subsidiary to treat that sale as a “deemed sale” of assets.  In 2013 the IRS issued its final regulations implementing the deemed sales provisions [Internal Revenue Code Sections 336(e) and 338(h)(10)].  Application of both sections of the Code requires the parties’ agreement to deemed sale treatment.  A deemed sale of stock has the following benefits to both parties:

To the Buyer:

1.            The seller treats the transaction as a capital transaction because stock is being sold.

2.            Since stock is a non-depreciable asset, there is no recapture of depreciation of the assets being transferred.

3.            As a sale of stock, the seller is able to jettison all of the liabilities that go with the corporation being sold.

4.            Avoidance of state sales taxes on value of the assets transferred (though some states may tax the stock transfer)

To the Seller:

1.            The buyer receives a stepped up basis in the assets owned by the acquired corporation if the price paid is greater than the adjusted basis in those assets.

2.            Re-titling assets such as motor vehicles is eliminated because the owner of the assets does not change. This is particularly useful to purchasers of assets consisting of fleets of motor vehicles.  Coincidentally, re-pro rating the vehicles during the remainder of the tax year is also avoided.

3.            The target corporation’s brand identity is preserved.  There will be no need to assign phone numbers or websites.  From a customer standpoint, the transaction can be invisible, giving the buyer the opportunity to realize continuity of business without disruption.

4.            There is no need to obtain new licenses from regulatory agencies unless transfers of control require regulatory approval.

The Buyer’s Downside:  Purchasing the target’s stock does carry risks.  Unlike an asset purchase, with the stock purchase goes all of the liabilities of the target, both known and unknown.  For this reason, particular attention must be paid during due diligence to things both readily discoverable (such as lawsuits, tax liens, security interests and other publicly available information) and not so discoverable (such as: tax audits and claims against the target that have not yet become lawsuits).  While the stock purchase agreement can address the target’s liabilities in the form of seller representations and warranties, those representations and warranties are only useful if the seller has the ability to back them up with its balance sheet.

While Sections 336(e) and 338(h)(10) have different applications, both have the same end point – the parties have the benefits of an asset transfer without the logistical problem of transferring assets.