Why does a Section 338(h)(10) or F-Reorganization election trigger an extra tax bill for S-Corp founders?

While a Section 338(h)(10) election gives the private equity buyer a valuable 15-year tax basis step-up under IRC Section 197, it treats the stock sale as a deemed asset sale for tax purposes. This reclassifies cash-basis receivables, inventory, and depreciation recapture from 20% long-term capital gains to 37% ordinary income and triggers state-level S-Corp entity taxes.

Why must the Tax Gross-Up Payment be calculated iteratively ("tax-on-tax")?

Because the cash Tax Gross-Up Payment paid by the Buyer to the Seller is itself treated as additional taxable purchase price consideration, a flat reimbursement leaves the Seller ~25% short. An iterative make-whole formula divides the incremental tax differential by (1 - effective tax rate) so the Seller nets 100% of straight stock-sale proceeds.

Section 338(h)(10) Tax Gross-Up PlaybookFree M&A Founder & Seller Proceeds Defense Tool

M&A Section 338(h)(10) & F-Reorganization Seller Tax Gross-Up Calculator

Private equity LOIs routinely slip a single sentence requiring Sellers to cooperate with a Section 338(h)(10) or F-Reorganization election—giving the Buyer a massive tax step-up while handing Founders a surprise $250,000–$850,000+ ordinary-income tax bill at closing. Model your iterative Tax Gross-Up below—then scan your LOI or APA free.

M&A LOI & Section 338(h)(10) Inputs

Headline M&A Enterprise Purchase Price ($)$6,000,000

Purchase Price Allocated to Ordinary-Income / Hot Assets (%)35% ($2,100,000)

State S-Corp Entity-Level Deemed Asset Sale Tax (%)3.5% ($210,000)

Surprise Seller Tax Hit

$567,000

Ordinary income spread + state entity tax

Iterative Tax Gross-Up

+$766,216

Includes tax-on-tax make-whole payment at closing

Founder Proceeds Saved

$766,216

100% buyer-funded Section 338(h)(10) election

Copy-Paste Section 338(h)(10) Seller Tax Gross-Up Covenant

“MANDATORY SECTION 338(h)(10) / F-REORGANIZATION TAX GROSS-UP: Sellers' obligation to join in any election under IRC Section 338(h)(10) or consummate a pre-closing F-Reorganization shall be strictly conditioned upon Buyer paying Sellers at Closing an additional cash Tax Gross-Up Payment (estimated at $766,216) sufficient to place Sellers in the exact net after-tax cash position (including taxes assessed on the Tax Gross-Up Payment itself) that Sellers would have realized had the transaction closed as a straight sale of stock taxed at long-term capital gains rates.”

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DESK ADJUSTER SUPPLEMENT REJECTION LETTER & XACTIMATE LINE-ITEM AUDIT
CLAIM NO: SUP-2026-55190 | CARRIER DESK REVIEW — SUPPLEMENT #1 RESPONSE

ITEM 1 — UNIVERSAL STARTER COURSE & HIGH-PROFILE HIP/RIDGE CAP (RFG ASTR / RFG RIDGC)
Supplement request for 280 LF of Universal Starter Row Shingles (RFG ASTR) and 145 LF of High-Profile Hip & Ridge Cap (RFG RIDGC) is DENIED. Desk Adjuster note: "Starter strip and hip/ridge cap are accounted for in the 10% field shingle waste factor; contractors can cut 3-tab shingles on site."

ITEM 2 — STEEP ROOF (7/12–12/12 PITCH) & TWO-STORY HIGH ACCESS CHARGES (RFG STEP / RFG HIGH)
Supplement request for Steep Roof Charges on 18.4 SQ of 9/12 pitch slopes (RFG STEP) and Two-Story High Roof Access on 24.0 SQ (RFG HIGH) is DENIED. Desk Adjuster note: "Base Xactimate shingle installation labor already accounts for standard residential roof pitch and ladder access."

ITEM 3 — VALLEY METAL LINER, CRICKETS & STEP FLASHING (RFG VMTL / RFG STEPF)
Supplement request for 68 LF of W-Valley Painted Metal (RFG VMTL), chimney saddle cricket framing, and 84 LF of Aluminum Step Flashing at sidewall dormers (RFG STEPF) is DENIED; contractor is instructed to weave shingles in valleys and reuse existing flashing.

ITEM 4 — OSHA FALL PROTECTION, DUMPSTER & EAGLEVIEW REPORT
Supplement request for OSHA Roof Harness & Safety Tie-Off Setup, 30-Yard Roll-Off Dumpster (DMO DUMP) for 2-layer shingle tear-off, and $95 EagleView Aerial Measurement Report reimbursement is DENIED as "contractor overhead."

ITEM 5 — GENERAL CONTRACTOR OVERHEAD & PROFIT (10% O&P) DENIAL
Request for 10% Overhead and 10% Profit is DENIED. Desk Adjuster note: "Our internal carrier guidelines do not pay O&P on residential roofing and exterior claims unless more than 5 separate licensed trades are subcontracted and pre-approved in writing."

Optional — Property State or Claim Context (e.g., "34 SQ Texas hail roof claim" or "Florida Category 3 water loss")

100% Stateless & Private • Saves $1,500 – $5,000 (In-House Estimating Cost) vs. Public Adjuster fee