M&A Section 338(h)(10) & F-Reorg Tax Election Gross-Up Redline
Private equity and strategic buyers love purchasing S-Corp or LLC equity while demanding a Section 338(h)(10) election or F-Reorganization so the buyer gets a stepped-up depreciation basis in your assets. However, treating a stock sale as a deemed asset sale converts portions of your payout from 20% long-term capital gains into 37% ordinary income and triggers state entity-level taxes—unless you mandate a full Buyer Tax Gross-Up covenant.
S-Corp Founder Hit With $410,000 Surprise IRS Bill After Signing "Standard" 338(h)(10) Clause
A B2B software founder sold his S-Corp for $6.5M and agreed in the LOI to "cooperate with Buyer’s Section 338(h)(10) election." At tax time, cash-basis receivables, depreciation recapture, and California S-Corp entity-level taxes cost the founder $410,000 more than a standard stock sale.
RedlineCore™ flags any mention of Section 338(h)(10), Section 336(e), or F-Reorganization lacking a "Tax Neutrality Gross-Up" and injects the exact iterative tax-on-tax gross-up covenant.
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Fixing one clause alone often fails when a buried definition, exhibit, or survival clause elsewhere in your Contractor & PA Supplement neutralizes your protection. Drop your PDF or Word (.docx) below for an instant, 100% anonymous cross-section audit.
“Sellers’ obligation to join in any IRC Section 338(h)(10) or Section 336(e) election or pre-closing F-Reorganization is expressly conditioned upon Buyer paying Sellers at Closing (or upon filing) a full Tax Gross-Up Payment ("Tax Adjustment Amount") sufficient to place Sellers in
What to Say to the Carrier Desk Adjuster / Re-Inspector
"We are happy to accommodate a Section 338(h)(10) or F-Reorg structure so you receive the 15-year § 197 tax basis step-up, provided the APA includes the standard Tax Gross-Up Adjustment making Sellers tax-neutral compared to a straight stock sale."
Why they drafted it this way: A stepped-up tax basis lets the buyer deduct the purchase price over 15 years under IRC § 197, creating millions in tax shields for the buyer while silently shifting the immediate tax bill onto the seller.
Mandatory Audit Checklist Points
- Condition any Section 338(h)(10), 336(e), or F-Reorg on a full Tax Gross-Up (including tax-on-tax)
- Lock in a binding Purchase Price Allocation (IRS Form 8594) schedule attached to the APA at signing
- Require Buyer to indemnify Sellers for any state-level PTE / franchise taxes triggered by the deemed asset sale
- Cap Seller cooperation costs and accountant review fees at Buyer’s expense
Paste Your Section 338h10 tax gross up M&A LOI redline Section or Upload Your Full Contractor & PA Supplement (.pdf / .docx)
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Frequently Asked Questions
What is a Tax Gross-Up in a Section 338(h)(10) M&A transaction?
A Tax Gross-Up requires the buyer to pay the seller the exact dollar difference between the seller’s tax bill under a straight stock sale (typically 20% capital gains) and the higher tax bill triggered by a deemed asset sale (ordinary income recapture + state entity tax), plus the tax owed on the gross-up payment itself.
Should a Section 338(h)(10) tax gross-up be negotiated at the LOI stage?
Yes. If the Letter of Intent (LOI) states the transaction will be structured as a 338(h)(10) or F-Reorg without mentioning tax neutrality, buyers often argue at the APA stage that the headline price already priced in the tax shift.
How do I redline Section 338h10 tax gross up M&A LOI redline traps in my Contractor & PA Supplement anonymously without creating an account?
Upload your Contractor & PA Supplement PDF or Word (.docx) draft to ClaimXray.com to run the "M&A Section 338(h)(10) & F-Reorg Tax Election Gross-Up Redline" defense cartridge 100% anonymously—with zero account registration, zero email login, and stateless in-memory processing. RedlineCore™ 4.0 flags Section 338h10 tax gross up M&A LOI redline exposure (typically $180,000 – $850,000+ in surprise seller tax liability; documented unredlined loss: $410,000 uncompensated tax hit), checks for cross-section overrides, and exports a ready-to-send Microsoft Word (.docx) Track-Changes file.
More Contractor & PA Supplement Redline Playbooks
View All Contractor & PA Supplement PlaybooksM&A Purchase Price Allocation (IRS Form 8594) & Goodwill Redline
In an asset purchase or deemed asset sale, IRC Section 1060 requires Buyer and Seller to file matching IRS Form 8594 schedules allocating the purchase price across 7 asset classes. If the APA gives Buyer unilateral control to prepare the allocation 90 days after closing, Buyer’s accountants can allocate huge sums to Class V/VI covenants not to compete or hard assets—taxing you at 37% ordinary income instead of 20% Class VII Goodwill.
M&A Transition Services Agreement (TSA) & Post-Closing Labor Cap
Buyers routinely insert a seemingly harmless sentence in the APA requiring the Seller and Founders to provide "Transition Services as reasonably requested by Buyer for up to 12 months." Without a hard weekly hour cap, market consulting rate after 30 days, and an explicit disclaimer of warranties, you can be trapped working 50 hours a week for free while facing indemnification claims if a post-closing migration glitches.
M&A Material Adverse Effect (MAE / MAC) Walk-Away Loophole Auditor
Between signing the APA (or binding LOI) and Closing, a broadly drafted Material Adverse Effect (MAE / MAC) clause gives the Buyer a free option to walk away—or hold a gun to your head to slash the purchase price by 20% the day before closing—if your monthly revenue dips due to seasonality, macro economy shifts, or the announcement of the deal itself.
M&A Subordinated Seller Note & Rollover Equity Preemptive Rights Auditor
When 15%–30% of your sale price is paid via a Subordinated Seller Promissory Note or Rollover Equity, two traps can wipe it out: (1) Buyer’s senior bank lender demands an unlimited "Payment Blockage" allowing the bank to halt your Seller Note payments indefinitely for any minor financial covenant trip; and (2) your minority Rollover Equity lacks preemptive anti-dilution and tag-along rights, allowing the PE sponsor to dilute your stake to zero via insider management fees and cram-down rounds.