Asset Deal vs Stock Deal: How the Tax Step-Up and 338(h)(10) Actually Work

If an interviewer asks you "Would a buyer rather do an asset deal or a stock deal?", the short answer is this: buyers usually prefer asset deals because of the tax step-up, sellers usually prefer stock deals because of simpler, lower taxes, and a 338(h)(10) election is a way to get the buyer's tax benefit while keeping the legal simplicity of a stock deal.

That's the headline. But the follow-ups are where candidates get exposed. Why does the step-up matter? Who actually pays more tax? When does 338(h)(10) work, and when doesn't it? Let's walk through it with real numbers so you can answer confidently.

The Two Basic Ways to Buy a Company

Every acquisition is legally structured in one of two ways. The structure changes what the buyer owns, what liabilities it inherits, and how both sides are taxed.

Stock deal

The buyer purchases the shares of the target from its owners. The company itself doesn't change: same legal entity, same contracts, same liabilities, same tax history.

• The buyer gets everything, including unknown or contingent liabilities (lawsuits, environmental issues, old tax exposures)
• Simpler to execute: no need to retitle every asset, though change-of-control clauses can still bite
• The target's tax basis in its assets carries over unchanged

Asset deal

The buyer purchases specific assets (and assumes specific liabilities) directly from the target company. The target's shareholders don't sell anything; the company does.

• The buyer picks what it wants and can leave unwanted liabilities behind
• More complex: contracts, permits and titles may need to be transferred one by one
• The buyer records the assets at the price it paid, which creates the tax step-up

What a Tax Step-Up Really Means

Every asset has a tax basis, roughly what the company paid for it minus the depreciation it has already deducted for tax purposes. A company that's been around for 20 years often has a tax basis far below what the business is worth today.

In an asset deal, the buyer gets a new tax basis equal to the purchase price, allocated across the assets. That increase is the step-up.

Why do buyers care? Because a higher basis means bigger depreciation and amortization deductions in the future, which means lower taxable income and lower cash taxes.

A few key points:

• In the US, goodwill and most acquired intangibles are amortized over 15 years for tax purposes (Section 197)
• Tangible assets like equipment get depreciated on their own schedules, often faster
• The purchase price is allocated across asset classes in a set order, with whatever is left over landing in goodwill

The step-up in numbers

Say a buyer pays $500M for a business whose assets have a tax basis of $200M.

• Step-up: $500M − $200M = $300M
• Assume it all ends up in goodwill and intangibles, amortized over 15 years: $20M of extra deductions per year
• At a 21% federal corporate rate: $4.2M of tax savings per year for 15 years
• Nominal total: $63M
• Present value at a 10% discount rate: roughly $32M

That ~$32M is real value to the buyer. In a stock deal with no election, it simply doesn't exist, because the old $200M basis carries over.

(We're ignoring state taxes here to keep the math clean. In practice, state taxes make the step-up a bit more valuable.)

Why Sellers Often Push Back: Double Taxation

If the step-up is so great, why isn't every deal an asset deal? Because for a standalone C corporation, an asset sale can trigger two layers of tax.

Here's how it works:

1. The corporation sells its assets and pays corporate tax on the gain
2. The corporation then distributes the remaining cash to shareholders, who pay tax again on their gain

In a stock sale, only the shareholders are taxed, once.

Worked example: standalone C corp

Same business: $500M price, $200M inside tax basis. The shareholders' basis in their stock is $50M. Use 21% for corporate tax and 20% for individual capital gains (ignoring the 3.8% net investment income tax and state taxes).

Asset sale:

• Corporate gain: $500M − $200M = $300M
• Corporate tax at 21%: $63M
• Cash distributed to shareholders: $437M
• Shareholder gain: $437M − $50M = $387M
• Shareholder tax at 20%: $77.4M
• Net to shareholders: ~$359.6M

Stock sale:

• Shareholder gain: $500M − $50M = $450M
• Shareholder tax at 20%: $90M
• Net to shareholders: $410M

The asset sale costs the sellers about $50M more. The buyer's step-up is only worth about $32M in present value. So the buyer can't profitably pay the sellers enough to make up the difference.

Result: standalone C corps are usually sold via stock deals.

Pass-through entities are different

If the target is an S corporation, LLC or partnership, there's no corporate-level tax. The gain flows through to the owners and is taxed once either way.

That makes asset-style treatment much cheaper for the seller, which is why step-ups are common when buying pass-through businesses. (The seller may still face some extra cost because part of the gain can be taxed as ordinary income, for example from depreciation recapture, but it's nowhere near double taxation.)

Enter 338(h)(10): The Best of Both Worlds

A Section 338(h)(10) election lets a deal be a stock purchase legally but an asset purchase for tax purposes.

The buyer gets:

• The tax step-up, just like an asset deal
• The legal simplicity of a stock deal: one entity changes hands, contracts generally stay in place

How the "deemed" transaction works

For tax purposes, the IRS pretends two things happened:

1. The "old" target sold all its assets to a "new" target at a price based on the deal value
2. The old target then liquidated and distributed the proceeds to its owner(s)

The gain shows up at the asset level, and the buyer starts fresh with stepped-up basis.

Who can use it

This is the part interviewers love to test. A 338(h)(10) election requires:

• The buyer is a corporation acquiring at least 80% of the target's stock (by vote and value) by purchase within a 12-month period
• The target is either:
  • A subsidiary of a corporate parent (part of a consolidated or affiliated group), or
  • An S corporation
• A joint election by buyer and seller (for an S corp, all shareholders must consent)

What it can't do: work for a standalone C corp owned by individuals or funds. That's exactly the case where double taxation would apply, so the rules don't offer this shortcut.

Why it doesn't cause double tax

• Corporate subsidiary: the parent would normally pay tax on selling its subsidiary's stock. With the election, the stock gain is ignored and the parent's group pays tax on the deemed asset sale instead. The deemed liquidation into the parent is generally tax-free. One layer of tax.
• S corp: the deemed asset sale gain passes through to the shareholders. One layer of tax.

When the Seller Says Yes (and When It Says No)

Even with only one layer of tax, the election can still change how much tax the seller pays. It all comes down to the gap between two numbers:

• Inside basis: the target's tax basis in its assets
• Outside basis: the seller's tax basis in the target's stock

With the election, the seller is taxed on gain over the inside basis. Without it, the seller is taxed on gain over the outside basis.

Case 1: Inside basis ≈ outside basis

A parent sells a subsidiary for $500M. Inside basis is $200M, outside basis is also $200M.

• Stock sale gain: $300M → tax of $63M
• 338(h)(10) gain: $300M → tax of $63M

The seller pays the same either way, and the buyer picks up ~$32M of value. Everyone wins. The buyer might even share some of that benefit through a slightly higher price.

Case 2: Outside basis much higher than inside basis

Same deal, but the parent's stock basis is $400M (maybe it bought the sub years ago at a high price).

• Stock sale gain: $100M → tax of $21M
• 338(h)(10) gain: $300M → tax of $63M

The election costs the seller $42M extra. The buyer's step-up is worth ~$32M. Even if the buyer handed over the full benefit as a price increase (a "gross-up"), it wouldn't cover the seller's extra tax. The election probably doesn't happen.

This is the real-world logic: an election makes sense only when the buyer's tax benefit exceeds the seller's incremental tax cost.

Related Elections Worth Knowing

You don't need to be a tax lawyer, but knowing these exist will make you sound sharp:

• Section 338(g): the buyer can make this one alone, for almost any target. The catch is that for a domestic target it usually triggers double tax (the sellers pay tax on their stock gain, and the target owes tax on the deemed asset sale, which the buyer now effectively bears). That's why it's mostly used for foreign targets.
• Section 336(e): similar result to 338(h)(10), but the buyer doesn't have to be a corporation. Useful when the buyer is, say, a private equity fund or individuals. Here the seller and target make the election.
• F reorganization: a common technique for S corp targets that achieves a step-up for the buyer while avoiding some of the technical risks of a 338(h)(10).

How This Shows Up in Your Merger Model

This is where tax structure meets the technical questions you'll actually get.

Stock deal (no election):

• The buyer writes up assets for book purposes, but tax basis doesn't change
• That mismatch creates a deferred tax liability (DTL): asset write-up × tax rate
• The new goodwill is not tax-deductible
• The target's NOLs survive, though Section 382 limits how fast they can be used

Asset deal or 338(h)(10):

• Book and tax bases are both stepped up, so no new DTL from the write-ups
• Goodwill becomes tax-deductible over 15 years
• The buyer doesn't inherit the target's NOLs or other tax attributes

If you model a stock deal and forget the DTL, your goodwill number will be wrong. If you model an asset deal and still create a DTL, it's also wrong. Interviewers check for this.

Interview Questions You Should Be Ready For

"Why would a buyer prefer an asset deal?" The tax step-up creates future depreciation and amortization deductions, which lower cash taxes. The buyer can also pick which liabilities to assume.

"Why would a seller prefer a stock deal?" For a C corp, an asset sale can trigger double taxation. A stock sale is also cleaner because the seller walks away from all liabilities.

"What is a 338(h)(10) election?" It treats a stock purchase as an asset purchase for tax purposes. The buyer gets a step-up while keeping the legal simplicity of a stock deal. It requires a corporate buyer and a target that's either an S corp or a subsidiary of a corporate parent, and both sides must agree.

"Can you do a 338(h)(10) on a standalone C corp owned by a PE fund?" No. The target must be an S corp or part of a corporate group.

"How do you know if the election is worth it?" Compare the present value of the buyer's tax savings to the seller's incremental tax cost. If the buyer's benefit is bigger, there's room to share it and make the election.

"Does a stock deal create a DTL?" Yes, when assets are written up for book purposes but not for tax. The DTL equals the write-up times the tax rate. In an asset deal or 338(h)(10), there's no new DTL from the write-ups.

The Takeaway

Remember the core trade-off: the buyer wants the step-up, and the seller wants to avoid extra tax. A 338(h)(10) election bridges that gap, but only for the right targets and only when the numbers work.

If you can explain that logic and back it up with a quick example like the $500M deal above, you'll be ahead of most candidates who just memorize "asset deals give a step-up" and stop there.