A Tax Election Does Not Rewrite the Deal

The LOI promises a stock purchase, continuity of the business, and cooperation with a tax election. Everyone believes the structure is settled.

Then the landlord asks for consent. The seller asks who will pay the added tax. The lender asks how its debt will be repaid. A shareholder who is not selling asks why their signature is needed.

The deal has not changed. The parties have started reading what they promised.

One transaction, three sets of consequences

Sections 338(h)(10) and 336(e) can give qualifying stock transactions deemed asset-sale treatment for federal income tax purposes. That does not convert the legal transaction into an asset purchase or resolve obligations in private agreements. The tax consequences arise under a separate set of rules. IRS, Form 8023 instructions; Treasury Regulation § 1.336-2

Keep three questions separate: what legally changes hands, how tax law treats that change, and what the existing contracts require because it happened.

Calling the structure “the best of both worlds” can obscure the work needed to make all three fit.

The company survives. The consent question remains.

Consider a fictional buyer acquiring all the stock of an operating company. The parties prefer a stock purchase because the company holds the customer contracts, lease, and operating assets. They also want an available tax election.

Assume the lease expressly requires landlord consent to a transfer of majority ownership. The company remains the tenant after closing, but the ownership transfer still triggers the agreed consent requirement.

The buyer has avoided changing the tenant's legal identity. It has not avoided this contractual condition.

The practical response is to identify the requirement early, determine who approaches the landlord, and decide whether consent is a closing condition. If the landlord requests a new guarantee or security deposit, the parties must decide who bears that cost. A tax allocation will not answer it.

A customer agreement may define change of control differently. A license may involve regulatory requirements rather than just a contract. The review must follow the actual language and applicable rules; legal continuity is a starting fact, not a blanket clearance.

“Cooperate” does not settle who pays

Suppose the same LOI says the seller will cooperate with the buyer's requested election. Later analysis shows that the seller's tax cost would be higher than under a conventional stock sale.

The buyer considers cooperation part of the agreed bargain. The seller considers additional compensation a prerequisite. Both may believe the tax adviser was supposed to resolve it.

A model can estimate consequences. It cannot supply a commercial agreement the parties never reached.

Before treating cooperation as settled, address who may request the election, what conditions apply, how incremental tax cost is measured, whether compensation is capped, and what happens if the expected benefit changes. The definitive documents should then allocate preparation, review, signature, filing, and consistent-reporting responsibilities.

For an S corporation target, Section 338(h)(10) requires participation by all shareholders, including those who retain stock. Section 336(e) has its own agreement requirements involving the target and shareholders. A promise by the negotiating shareholder is not a substitute for the required parties' participation. IRS, Form 8023 instructions; Treasury Regulation § 1.336-2(h)

Separate repayment from release

Return to the hypothetical company's debt. Assume the seller personally guaranteed it, the buyer expects refinancing at closing, and the guarantee requires a written lender release.

A purchase-agreement promise to protect the seller is not the lender's release. It may allocate responsibility between buyer and seller while leaving the lender's rights intact under the assumed documents.

The closing plan needs the actual payoff, replacement financing, and release requirements. If refinancing fails, the parties need to know whether the transaction can still close and on what terms.

This is a distinct issue from the tax election. It belongs in the same transaction plan because it affects whether the seller can leave and whether the buyer can operate as intended.

Turn the LOI into an accurate statement of the bargain

An LOI does not need to reproduce the purchase agreement. It should avoid presenting an unresolved structural assumption as a completed decision.

Before committing to the proposed approach, identify:

• Which material contracts or licenses require a consent or other action.

• Which parties must participate in the tax election.

• Which economic assumptions remain subject to modeling and agreement.

• Which obligations require an actual third-party release.

• What happens if an essential assumption fails.

The exact drafting depends on the intended binding effect and transaction facts. The broader danger of casual LOI language is explored in The Most Dangerous Word in an M&A Letter of Intent.

For the tax-specific questions, read the 338(h)(10) analysis and 336(e)/338(h)(10) comparison. The contractual work remains even when the tax structure is available.

A sound structure should survive contact with the documents. Confirm that before its shorthand becomes the basis for the price.

For a proposed acquisition structure, discuss the legal commitments with Tolbert Legal.

Educational information only; not legal, tax, accounting or investment advice. Scenarios are fictional and assume the stated contract terms. Election eligibility and transaction requirements need review of the actual facts and governing law.