What South Carolina tax consequences followed a federal Internal Revenue Code § 338(h)(10) election under the 2009 guidance?

Plain-English summary

The South Carolina Department of Revenue explained how a federal Internal Revenue Code § 338(h)(10) election affected several state taxes. Although the legal form was a stock sale, federal income-tax law treated the target as selling its assets and the buyer as acquiring those assets with a stepped-up or stepped-down basis.

South Carolina automatically followed a valid federal election for state income tax; the parties could not elect separately for only federal or only South Carolina purposes. The target's deemed-sale gain had to be classified and sourced: business-asset gain was generally apportionable, real-property gain above depreciation recapture was allocated to the property's state, and nonbusiness-asset gain was allocable.

The deemed asset sale existed only for income-tax purposes. The ruling found no South Carolina sales or use tax and no deed recording fee from the election itself because no actual asset sale or real-property transfer occurred. For personal-property tax, however, the buyer generally used the federal stepped-up or stepped-down asset basis, subject to South Carolina adjustments.

What this means for you

Buyers and sellers

A federal § 338(h)(10) election automatically carried into South Carolina income tax. Model the target's short-period income, asset-by-asset sourcing, basis changes, and state credits before closing.

Corporate tax teams

The ruling distinguished net gains on business property, gross proceeds from inventory, allocated real-property gain, and short-period apportionment. An alternative apportionment method could apply if the standard formula did not fairly represent South Carolina activity.

Credit and property-tax reviewers

Unused job credits could transfer with substantially all assets if statutory conditions were met, but the buyer did not restart a new five-year credit period. A deemed disposition could also trigger economic-impact-zone credit recapture, while acquired property took the adjusted federal basis for the described personal-property tax calculations.

Common questions

Q: Was a separate South Carolina § 338(h)(10) election required?
A: No. A valid federal election automatically applied for South Carolina income-tax purposes.

Q: Did the deemed asset sale trigger South Carolina sales tax?
A: No. The ruling said the election recharacterized the transaction only for income tax; there was no asset sale for sales-tax purposes.

Q: Did it trigger a deed recording fee?
A: No. No realty was actually transferred to another person merely because of the federal election.

Q: How was deemed-sale gain sourced?
A: It depended on the asset and facts. Business-asset gain was generally apportioned, while specified real-property and nonbusiness gain was allocated under the rules described.

Q: What happened to state tax credits?
A: Each credit statute controlled. The ruling allowed possible transfer of qualifying unused job credits but warned about limitations, eligibility rules, and potential recapture of economic-impact-zone credits.

Citations and references

• Internal Revenue Code §§ 338 and 338(h)(10) (qualified stock purchase treated as an asset acquisition)
• S.C. Code §§ 12-6-40 and 12-6-50 (federal conformity and exclusions)
• S.C. Code §§ 12-6-2220, 12-6-2240, 12-6-2252, 12-6-2295, and 12-6-2320 (allocation, sales factor, and alternative apportionment)
• S.C. Code §§ 12-6-3360 and 12-14-60 (job and economic-impact-zone credits)
• S.C. Code § 12-24-10 (deed recording fee)
• S.C. Code § 12-37-930 and Regulation 117-1840.1 (personal-property valuation)

Source

• Landing page: https://dor.sc.gov/advisory-opinion-search
• Original PDF: https://dor.sc.gov/sites/dor/files/policies/RR09-4.pdf

Original ruling text

State of South Carolina

Department of Revenue
301 Gervais Street, P. O. Box 125, Columbia, South Carolina 29214
Website Address: http://www.sctax.org

SC REVENUE RULING #09-4

SUBJECT:

Internal Revenue Code §338(h)(10) Election
(All Taxes)

EFFECTIVE DATE:

Applies to all periods open under the statute.

SUPERSEDES:

All previous advisory opinions and any oral directives in conflict
herewith.

AUTHORITY:

S. C. Code Ann. Section 12-4-320 (Supp. 2008)
S. C. Code Ann. Section 1-23-10(4) (2008)
SC Revenue Procedure #09-3

SCOPE:

The purpose of a Revenue Ruling is to provide guidance to the public
and to Department personnel. It is an advisory opinion issued to apply
principles of tax law to a set of facts or general category of taxpayers. It
is the Department’s position until superseded or modified by a change in
statute, regulation, court decision, or another Departmental advisory
opinion.

I. General Overview
A purchasing corporation 1 making a qualified stock purchase (i.e., the purchase of at least 80%
of the total voting power and value of the stock of a corporation during a 12 month acquisition
period) of a target corporation 2 may make a joint election under Internal Revenue Code §338,
“Certain Stock Purchases Treated as Asset Acquisitions,” to treat the stock purchase as an asset
acquisition.
Internal Revenue Code §338(h)(10), “Elective Recognition of Gain or Loss by Target
Corporation, Together with Nonrecognition of Gain or Loss on Stock Sold by Selling
Consolidated Group,” allows a target corporation that was a member of the selling
consolidated group before the transaction to be treated as a member of the selling consolidated
group with the stock sale transaction treated as if the target corporation had sold all of its assets
at the close of the acquisition date at fair market value in a single, fully taxable transaction,
1

The term “purchasing corporation” means any corporation which makes a qualified stock purchase of
stock of another corporation.
2

The term “target corporation” means any corporation the stock of which is acquired by another
corporation in a qualified stock purchase.

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distributed the proceeds of the sale to the seller 3 (the corporation that owns the target, e.g.,
another member, parent, or Q Sub) in tax free deemed liquidation under Internal Revenue
Code §332, and treated as a new corporation which purchased all the assets as of the beginning
of the day after the acquisition date (i.e., repurchased its own assets in a hypothetical sale). As
a result, the purchasing corporation receives a stepped up (or stepped down) basis in the assets
acquired from the target corporation and a gain or loss on the deemed sale of assets is
recognized by the target on its old consolidated return if the target is a member of the selling
consolidated group, or the old target’s separate return if the target was a member of an
affiliated group filing separate returns or an S corporation.
An Internal Revenue Code §338(h)(10) election can be made until the 15th day of the 9th month
after the month in which the acquisition date occurs. The election must be made jointly by both
the seller and the purchaser.
The practical effect of an Internal Revenue Code §338(h)(10) election is summarized as
follows:

Parent
(C or S Corp)

80% of Stock for
Cash

Acquirer

Cash for Stock

Deemed Liquidation

Sub
(C Corp or Q
Sub

Deemed Cash for
Assets

Sub
(C Corp or Q
Sub

Deemed Sale of
Assets

Target
(old)

1.

Target
(new)

The target is treated as if it had sold all of its assets in a single, fully taxable transaction and
recognizes gain or loss on the deemed sale of the assets (i.e., there is an asset sale for
income tax purposes; the form of the transaction is a stock sale).

3

An Internal Revenue Code §338(H)(10) election cannot be made for a target corporation unless it is
acquired from a selling consolidated group, a selling affiliate, or an S corporation shareholder(s).

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2. The target is generally treated as making the deemed sale and then distributing all of its
assets in a complete liquidation. The target’s tax year ends on the date of acquisition.
Generally, for federal income tax purposes, the target corporation’s short period return is
included in the selling parent’s federal consolidated return.

3. Any gain or loss on the actual sale of the stock in the target is not recognized by the selling
   group.
4. A purchasing corporation (sometimes referred to as the “new target”), using the same
   employer identification number of the target corporation, is treated as if it had purchased
   all the assets of the target corporation (sometimes referred to as the “old target”), and
   begins business the following day. The purchasing corporation (“new target”) receives a
   stepped up (or down) basis in the assets acquired from the (old) target.
   The purpose of this advisory opinion is to provide guidance concerning South Carolina
   income tax, sales tax, deed recording fee, and personal property tax consequences of an
   Internal Revenue Code §338(h)(10) election.

II. Income Tax Consequences
A. Conformity to Federal Election
Code Section 12-6-40, “Application of Federal Internal Revenue Code to State Tax Laws”,
provides that all elections made for federal income tax purposes in connection with Internal
Revenue Code Sections adopted by South Carolina automatically apply for South Carolina
income tax purposes unless otherwise provided. Code Section 12-6-40 and Code Section 12-650, “Internal Revenue Code Sections Specifically not Adopted by State,” provide that South
Carolina has adopted Internal Revenue Code §338 and related regulations. 4
Accordingly, an Internal Revenue Code §338(h)(10) election made by a C corporation or an S
corporation for federal income tax purposes automatically applies for South Carolina income
tax purposes (i.e., a separate South Carolina election is not made). Further, the election may
not be made solely for federal income tax purposes or solely for South Carolina income tax
purposes.
B. Treatment of Gain from Sales of Assets
In an Internal Revenue Code §338(h)(10) transaction, the target is treated as if it had sold all
of its assets in a single, fully taxable transaction and recognizes gain or loss on the deemed
sale of the assets (i.e., there is an asset sale for income tax purposes; the form of the
transaction is a stock sale). This results in sourcing issues and making a determination as to
whether the gain from the deemed sale of assets recognized by the target subsidiary is
apportionable business income, allocable nonbusiness income, or a combination.
4

Note that South Carolina has not, however, adopted Internal Revenue Code §§1501 - 1505 relating to
consolidated tax returns.

3

Code Section 12-6-2220 specifically lists items of income that must be directly allocated. This
statute is generally applicable to nonbusiness items of net income. Code Section 12-6-2240
provides that all income remaining after allocation is apportioned. Accordingly, the proper
sourcing and the amounts used in the apportionment factors depend on the facts and
circumstances.
Based on the above statute, the target subsidiary’s gain from the deemed sale of assets used in
the business is generally apportionable business income. However, the target subsidiary’s
gains and losses from the sale of real property less all related expenses are allocable income
and are allocated to the state in which the real property is located except to the extent that
gain represents the return of amounts deducted as depreciation. The amount of gain which
represents the return of amounts deducted as depreciation is allocated to South Carolina to
the extent of depreciation previously deducted in computing South Carolina taxable income.
Gain in excess of recaptured depreciation is allocated to the state where the real property is
located whether or not the real property was used in or connected with the taxpayer’s trade
or business. The target subsidiary’s gain from the deemed sale of assets not used in the
business is allocable income.
C. Apportionment Factors
The single sales factor apportionment method is provided in Code Section 12-6-2252. Code
Section 12-6-2295 provides a list of items included and excluded from the term “sales.”
Accordingly, the following provides guidance concerning the apportionment of income in an
Internal Revenue Code §338(h)(10) election:

1. Net gains (not the selling price) from the sale of tangible and intangible personal property
   used in the business (other than inventory and other property sold in the ordinary course
   of business) from the deemed sale are included in the target subsidiary’s sales factor.
2. The gross proceeds from the sale of inventory and other property sold in the ordinary
   course of business, for example, from the deemed sale is included in the target
   subsidiary’s sales factor.
3. The sales factor does not include gain which is allocated pursuant to Code Section 12-62220, such as a gain from the sale of real property (see discussion above.)
4. The gain and short period income is apportioned based on apportionment factors for the
   short period.
   Note: The above guidance may be different if the statutory apportionment formula does not
   fairly represent the extent of the taxpayer’s business within South Carolina. Code Section 126-2320 provides that such taxpayer may petition for, or the Department may require, an
   alternative method. See SC Revenue Procedure #09-1 for application procedures.

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D. Filing Obligations
Code Section 12-6-4410(A) provides that a taxpayer’s taxable year must be the same as the
taxpayer’s taxable year for federal income tax purposes. However, Code Section 12-6-50
provides that South Carolina has not adopted Internal Revenue Code §§1501 - 1505 relating to
consolidated tax return rules. With respect to taxpayers filing consolidated federal returns, the
short-period return for the target subsidiary is not due until the extended due date of the selling
parent’s return (in many cases, this is more than one year from the close of the target’s short
period). Since, as a practical matter, South Carolina’s filing requirements follow the federal
rules, the taxpayer’s South Carolina income tax return cannot be prepared and filed before the
federal income tax return. As a result, a penalty and interest imposed due to the federal filing
situation will be waived. 5
E. Income Tax Credits and Recapture
When making an Internal Revenue Code §338(h)(10) election, a taxpayer transferring unused
credits should carefully examine the particular South Carolina credit statute to determine if the
unused credits can be transferred or sold, whether there are any recapture provisions, and
review the requirements for eligibility of new credits. Several examples of the income tax
credit consequences of an Internal Revenue Code §338(h)(10) election are provided below.
Job Tax Credit. Code Section 12-6-3360(I) provides that a taxpayer may assign its rights to its
job tax credit to another taxpayer if it transfers all, or substantially all, of the assets of a trade
or business or operating division of a taxpayer related to the generation of the jobs tax credits
to that taxpayer if the required number of new jobs is maintained for that amount of credit.
Unused tax credits may be transferred and continued by the succeeding taxpayer subject to the
limitations of Section 12-6-3320. 6 Code Section 12-6-3360(A) and (F) sets forth the
requirements for creating a new job tax credit for qualifying new jobs. In other words, if the
target corporation created 100 new, full time jobs in the past and has $500,000 of unused job
tax credits and carryovers, the purchasing corporation is eligible to use the unused credits and
carryovers subject to any restrictions. The purchasing corporation is not, however, considered
to have created the 100 new jobs and is not eligible to claim the credit for a new, five year
credit period.

5

The Department is authorized to waive, dismiss, or reduce penalties under Code Section 12-54-160.
There is no authority granting the Department the right to waive interest (see Code Section 12-4-320(3)),
but on occasions interest has been deemed to be in the nature of a penalty and waived. See Colonial Life
& Accident Insurance Company v. South Carolina Tax Commission, 248 S.C. 334 (1966), and Texaco,
Inc., v. Robert C. Wasson, 269 S.C. 255 (1977). See also SC Revenue Ruling #89-10 addressing the
return due date for a South Carolina subsidiary involved in a Internal Revenue Code Section 338(h)(10)
transaction and the waiver of certain penalties.

6

Code Section 12-6-3320 provides that the provisions of Internal Revenue Code §383 (Special
Limitations on Certain Excess Credits) are applicable to all income tax credits available to a
corporation for South Carolina income tax purposes.

5

Economic Impact Zone Credit and Recapture. Code Section 12-14-60 provides that “economic
impact zone qualified manufacturing and productive equipment property” eligible for the credit
includes property acquired by the taxpayer if the original use commences with the taxpayer
inside the economic impact zone. If an Internal Revenue Code §338(h)(10) election is made,
the assets acquired by the purchasing corporation, even assets less than one year old, are not
eligible for the investment tax credit since the original use of the property did not begin with
the taxpayer inside the economic impact zone.
Further, Code Section 12-14-60(E) provides that if the taxpayer disposes of the qualified
manufacturing and productive equipment property before the end of the applicable recovery
period, then the unearned portion of the credit must be recaptured. Subsection (F) further
provides that if the credit is recaptured, then the basis of the property must be increased in the
year of recapture. As a result, if an Internal Revenue Code §338(h)(10) election is made, the
deemed sale of the assets is treated as a disposal of the assets and may trigger recapture of the
economic impact zone credit claimed by the (old) target corporation.

III. Sales Tax Consequences
A taxpayer making an Internal Revenue Code §338(h)(10) election is making an election to
treat a stock purchase as an asset acquisition (i.e. a deemed asset sale) for income tax purposes
only. For sales tax purposes, there is no asset sale. Accordingly, there is no South Carolina
sales or use tax consequences from an Internal Revenue Code §338(h)(10) election.

IV. Deed Recording Fee Consequences
The deed recording fee in Chapter 24 of Title 12 is imposed for the privilege of recording a deed
in each county (i.e., recorded with the clerk of court or register of deeds) with respect to any
deed whereby any lands, tenements or other realty is transferred to another person. Code Section
12-24-40 lists transfers exempt from the deed recording fee.
For deed recording fee purposes, a “transfer” of reality to another person has not taken place
under Code Section 12-24-10. Accordingly, there is no South Carolina deed recording fee
consequence from an Internal Revenue Code §338(h)(10) election.

V. Personal Property Tax Consequences
Manufacturers. Code Section 12-37-930 provides for the depreciation allowances for
manufacturer’s machinery and equipment. For personal property tax purposes, the original cost
of the property is reduced by an annual depreciation percentage. “Original cost” is defined as
gross capitalized cost, including property on which the taxpayer made the election allowed
pursuant to §179 of the Internal Revenue Code, as shown by the taxpayer’s records for income
tax purposes. In the year of acquisition, depreciation is allowed as if the property were owned
for the full year. Therefore, if an Internal Revenue Code §338(h)(10) election is made, the

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federal income tax basis of the deemed assets acquired by the purchasing corporation (stepped
up or stepped down basis), excluding adjustments for Internal Revenue Code §179 and other
Internal Revenue Code sections concerning depreciation not adopted by South Carolina (see
Code Section 12-6-50), is used for South Carolina personal property tax purposes.
Merchants. Regulation 117-1840.1 provides that the fair market value of merchants’ furniture,
fixtures, and equipment shall be the depreciated value as shown by the merchants records for
income tax purposes, provided however, that in no event is the original cost of the property to be
reduced by more than 90% of the original capitalized cost. Therefore, if an Internal Revenue
Code §338(h)(10) election is made, the federal income tax basis of the assets acquired by the
purchasing corporation (stepped up or stepped down basis), excluding adjustments for Internal
Revenue Code §179 and other Internal Revenue Code sections concerning depreciation not
adopted by South Carolina (see Code Section 12-6-50), is used for South Carolina personal
property tax purposes.
SOUTH CAROLINA DEPARTMENT OF REVENUE

s/Ray N. Stevens
Ray N. Stevens, Director
, 2009
March 31
Columbia, South Carolina

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