Internal Revenue Code Section 336(e) Elections: Basic Overview
The U.S. Treasury Department recently issued final regulations allowing certain taxpayers to make a special election to treat a disposition of domestic company stock as a disposition of that company's assets for U.S. federal income tax purposes. Depending on the facts of each particular disposition event, some taxpayers will benefit from making this election and others will not. Each disposition event must be separately analyzed to determine if this election is beneficial or should not be made.
Generally, a joint section 336(e) election allows (i) domestic corporate owners or (ii) S corporation shareholders who dispose of 80 percent or more (by vote and value within a 12-month acquisition period) of the stock of certain of their corporations to treat such disposition as an asset sale rather than as a stock sale for U.S. federal income tax purposes (a "qualified stock disposition"). When available, the election allows the corporation disposed of by the domestic corporate owners or the S corporation shareholders to recognize its gains or losses as if it sold all of its assets, and pay the tax, if any, on that deemed sale, thereby providing that corporation with a fair market value basis in its assets. The election is available only if the domestic corporate owners or the S corporation shareholders (the "Seller") dispose of at least 80 percent of the stock of a domestic target corporation ("Target") in a sale, exchange, or distribution. Dispositions to related persons do not count in determining whether a qualified stock disposition has taken place.
More specifically, the section 336(e) election is available where (i) a single domestic corporation that is the owner of at least 80 percent of the stock of a Target disposes of at least 80 percent of such stock in a taxable disposition to unrelated persons, (ii) multiple members of the same consolidated group owning in the aggregate at least 80 percent of the stock of a Target (such members are treated as a single Seller for purposes of the election) dispose of at least 80 percent of such stock in a taxable disposition to unrelated persons, or (iii) owners of at least 80 percent of the stock of an S corporation Target dispose of at least 80 percent of such stock in a taxable disposition to unrelated persons. On the other hand, a partnership or individual that disposes of stock in a domestic corporation (other than an S corporation) cannot make a section 336(e) election. There is no restriction, however, regarding the acquiror of the Target stock in a disposition transaction (e.g., acquirors of Target stock may be individuals, partnerships, trusts, or corporations, and in each case, domestic or foreign).
The election must be made jointly by the Seller and Target. The Seller and Target must enter into a binding, written agreement to make the election by the due date (as extended) of the Seller's or the Target's U.S. federal income tax return, whichever is earlier, for the year in which the qualified stock disposition takes place (or, in the case of an S corporation Target, by the due date (as extended) of the S corporation Target's U.S. federal income tax return). In the case of an S corporation, all S corporation shareholders (not just those disposing of their stock) must enter into a binding agreement with the S corporation Target to make the election. In addition to the binding, written agreement, a section 336(e) election statement must be attached to the U.S. federal income tax returns of the Seller and Target (or, in the case of an S corporation Target, attached to the U.S. federal income tax return of the S corporation Target) for the year of the qualified stock disposition. A protective section 336(e) election is permitted if there is uncertainty as to whether a disposition qualifies for the election.
If the parties to an agreement (such as a stock purchase agreement) do not wish to make a section 336(e) election for a qualified stock disposition (or a disposition that could be a qualified stock disposition), we suggest the following language be included in the agreement:
The parties agree that no election pursuant to Section 336(e) of the Code (or under any similar state, local, or foreign law) shall be made with respect to Target in connection with the transactions contemplated by this Agreement.
On the other hand, if the parties wish to make a section 336(e) election, or it has not been determined whether this election should or should not be made, please contact a member of the Jones Day tax practice in order to either craft the necessary language to be included in the agreement, or analyze the facts to determine whether this election would be beneficial.
For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.
Patrick J. Brown, Jr.
Lester W. Droller
Andrew M. Eisenberg
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