When a buyer and seller jointly elect under IRC § 338(h)(10) to treat a stock purchase as a deemed asset sale, and that deemed sale generates a loss for the acquired corporation, does that loss properly show up in the corporation's Tennessee excise tax base, and can the corporation carry that loss forward to later years even though federal tax rules treat it as a legally distinct "new" corporation after the transaction?

Subject

Whether a Section 338(h)(10) deemed-asset-sale loss and its resulting NOL carryforward are recognized for Tennessee excise tax purposes.

Plain-English summary

The Tennessee Department of Revenue ruled that a loss generated by a federal IRC § 338(h)(10) "deemed asset sale" election properly counted as Tennessee taxable income (a net loss), and that the acquired corporation may carry that net operating loss (NOL) forward to future years — even though federal tax law fictionally treats the transaction as if the "old" corporation liquidated and a brand-new corporation emerged in its place.

When a buyer purchases 100% of a target's stock but it and the seller jointly elect under IRC § 338(h)(10), federal law re-characterizes the transaction as a sale of the target's assets rather than its stock. This generates gain or loss to the target based on the difference between the purchase price and its asset basis — here, a loss, because the purchase price was below basis. On the first question, the Department found Tennessee's excise tax statute doesn't require any adjustment that would override this federal treatment — Tennessee taxable income starts from federal taxable income, and nothing in Tennessee's addition/subtraction adjustment rules carves out Section 338(h)(10) gains or losses for different treatment — so the loss properly flowed into the corporation's Tennessee return for the short tax period in which the deemed sale occurred.

The harder question was whether the resulting NOL could later be used, since federal regulations treat the transaction as creating a legal fiction: "Old" target corporation is treated as having sold all its assets and then liquidated into its former parent, while a wholly distinct "New" target corporation is treated as having bought those assets fresh. If Tennessee followed that fiction, the NOL generator ("Old" target) would have "disappeared," and its NOL would be lost to a "successor" under Tennessee's usual no-NOL-transfer-on-merger rule. But the Department held Tennessee does not adopt the federal Section 338 fiction for state tax purposes — citing the Tennessee Court of Appeals' rule that federal tax law interpretations aren't binding on Tennessee courts interpreting Tennessee tax law. Since the corporation didn't actually terminate its existence or liquidate into anyone — it kept the same corporate identity, federal EIN, and Tennessee account number throughout — it is, as a matter of Tennessee law, the very same taxpayer before and after the transaction, not a "successor." That means the ordinary rule barring NOL transfer to a successor never comes into play at all: the corporation simply carries forward its own loss, the same way any continuously-existing corporation would.

What this means for you

Corporate buyers and sellers using Section 338(h)(10) elections

Tennessee doesn't automatically follow the federal "old company liquidates, new company emerges" fiction that a Section 338(h)(10) election creates federally. For Tennessee excise tax purposes, if the target corporation actually continues to exist (same corporate identity, same EIN, same state tax account) after the transaction, it remains the same taxpayer — meaning any NOL the deemed asset sale generates stays available to that same corporation going forward, not lost to a "successor" analysis. This is a favorable divergence from federal treatment worth factoring into deal structuring and post-acquisition tax planning.

Accountants and tax professionals

This ruling is an important reminder that Tennessee franchise/excise tax law is not automatically bound by federal tax fictions, even when Tennessee's tax base starts from federal taxable income (per Little Six Corp. v. Johnson and Tidwell v. Berke). The key factual anchor for the "same taxpayer, not a successor" conclusion was that the target corporation never actually terminated or liquidated as a matter of state corporate law — it just changed ownership. If your client's post-acquisition structure involves an actual merger, conversion, or liquidation alongside the Section 338(h)(10) election, the standard NOL-successor analysis (Tenn. Code Ann. § 67-4-2006(c)(2)-(3)) would need to be revisited separately.

Common questions

Q: Does a federal IRC § 338(h)(10) election automatically flow through to Tennessee's excise tax the same way it does federally?
A: The loss itself flows through, because Tennessee's addition/subtraction adjustments don't override the federal Section 338(h)(10) treatment — but the fictional two-corporation, old-company-liquidates structure the election creates federally is not adopted for Tennessee purposes.

Q: Does a corporation lose its NOL if it's subject to a Section 338(h)(10) deemed asset sale as part of a stock acquisition?
A: Not if the corporation actually continues to exist afterward (same corporate identity, EIN, and state tax account) — Tennessee treats it as the same taxpayer, not a successor, so the ordinary NOL-transfer-to-successor bar never applies.

Q: Are Tennessee courts bound by federal tax regulations when interpreting Tennessee tax statutes?
A: No. Tennessee courts have held that federal tax law rulings are not binding when interpreting Tennessee tax law, even on issues (like Section 338 elections) where the underlying transaction is federally defined.

Q: Does this ruling apply to other Section 338(h)(10) transactions?
A: No. A Tennessee revenue ruling is advisory only and not binding on the Department, even for the taxpayer who requested it, though the "Tennessee doesn't adopt the federal Section 338 fiction" analysis is of general relevance to similarly structured acquisitions.

Citations and references

Statutes, rules, and cases:

• Tenn. Code Ann. §§ 67-4-2007(a), 67-4-2004(29) (excise tax on net earnings of corporations)
• Tenn. Code Ann. § 67-4-2006(a)(1) (definition of "net earnings"/"net loss," starting from federal taxable income)
• Tenn. Code Ann. § 67-4-2006(b)-(c) (addition/subtraction adjustments; no override for Section 338(h)(10) transactions)
• Tenn. Code Ann. § 67-4-2006(c)(2) (separate-entity rule; NOL taken only by the taxpayer that generated it)
• Tenn. Code Ann. § 67-4-805(c)(i) (prior-law 15-year NOL carryforward provision, applicable at the time of the transaction)
• TENN. COMP. R. & REGS. 1320-6-1-.21 ("Rule 21") (pre-recodification separate-entity NOL rule)
• 26 U.S.C. § 338(a), (h)(10); Treas. Reg. § 1.338(h)(10)-1 (federal deemed asset sale election and "Old"/"New" corporation fiction)
• Little Six Corp. v. Johnson, 1999 WL 336308 (Tenn. Ct. App. 1999); Tidwell v. Berke, 532 S.W.2d 254 (Tenn. 1975) (federal tax rulings not binding on Tennessee tax law interpretation)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/06-25fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 06-25

WARNING
Revenue rulings are not binding on the Department. This presentation of the ruling in a
redacted form is information only. Rulings are made in response to particular facts
presented and are not intended necessarily as statements of Departmental policy.

SUBJECT
The inclusion in Tennessee taxable income of a loss arising from a deemed asset sale under IRC
§ 338(h)(10), and the ability of the taxpayer to carry forward the resulting Tennessee net
operating loss to subsequent years for Tennessee excise tax purposes.
SCOPE
Revenue rulings are statements regarding the substantive application of law and statements of
procedure that affect the rights and duties of taxpayers and other members of the public.
Revenue rulings are advisory in nature and are not binding on the Department.
FACTS
Buyer, a corporate entity legally and commercially domiciled outside of Tennessee, acquired
100% of the stock of [CORPORATION], another corporate entity, during [YEAR].
[CORPORATION] was a calendar year taxpayer that later switched to a fiscal year and is doing
business in Tennessee and filing Tennessee franchise and excise tax returns. Prior to its
acquisition by Buyer, [CORPORATION] was wholly owned by another corporate entity, Seller.
Buyer, [CORPORATION], and Seller are all treated as Subchapter C corporations for federal tax
purposes. None has ever been treated as an S corporation for federal tax purposes.
Although Buyer acquired [CORPORATION] through a stock purchase, Buyer and Seller made a
joint election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended
(“Section 338(h)(10)”), which resulted in the transaction being treated as a sale of assets by
[CORPORATION] (“deemed asset sale”) for federal income tax purposes rather than a sale of
[CORPORATION]’s stock by the Seller. 1 The purchase price paid by Buyer was less than the
1

For federal income tax purposes, Section 338(a) of the Internal Revenue Code of 1986, as amended, allows a
corporation (“P”) that purchases 80% or more of the stock of a corporation (“T”) to elect to have the acquisition
treated as a purchase of T’s assets. Following the election, T is treated as if it sold all of its assets at a price
determined by P’s basis in T’s stock. The result of the election is that the difference between the purchase price of
T’s assets and its basis is recognized as gain or loss to T, and the basis of the assets is stepped up or down, as the
case may be.

If T is part of a “selling consolidated group,” P and the sellers of T’s stock may also jointly elect under Section
338(h)(10) to treat the transaction as a deemed asset sale followed by a liquidation. 26 U.S.C. § 338(h)(10); Treas.
Reg. § 1.338(h)(10)-1(c)(1). A “selling consolidated group” is the consolidated group of which T is a member on the
acquisition date. Treas. Reg. § 1.338(h)(10)-1(b)(2). Under this election, T’s gain or loss on the deemed asset sale is

tax basis of [CORPORATION]’s assets; therefore, the deemed asset sale generated a tax loss for
[CORPORATION]. Pursuant to the Federal Consolidated Return Regulations, Seller utilized
[CORPORATION]’s loss on the deemed asset sale in its [YEAR] consolidated federal income
tax return.
[CORPORATION] filed a Tennessee franchise and excise tax return for the short period ended
in [YEAR]. The excise tax base incorporated the loss generated by [CORPORATION]’s deemed
asset sale. As a result, for excise tax purposes, [CORPORATION] reported an overall net loss on
the [YEAR] short period return. Following its acquisition by Buyer, [CORPORATION]
maintained its corporate identity, its Federal Employee Identification Number, its Tennessee
account number, and continues to use the assets it owned prior to its acquisition by Buyer.
[CORPORATION] has continued to file Tennessee franchise and excise tax returns.
[CORPORATION] has not used the net operating losses reported on the [YEAR] short period
return to offset taxable income in subsequent years.
QUESTIONS
1.
Was the loss stemming from [CORPORATION]’s deemed asset sale under the Section
338(h)(10) election properly reflected in [CORPORATION]’s taxable income on the Tennessee
franchise and excise return for the short period ending in [YEAR]?
2.
For Tennessee excise tax purposes, may [CORPORATION] carry forward to subsequent
years the loss generated on its [YEAR] short period return?
RULINGS
1.
Yes. The loss stemming from [CORPORATION]’s deemed asset sale under the Section
338(h)(10) election was properly reflected in [CORPORATION]’s taxable income on the
Tennessee franchise and excise return for the short period ending in [YEAR].
2.
Yes. For Tennessee excise tax purposes, [CORPORATION] may carry forward to
subsequent years the loss generated on its [YEAR] short period return.
ANALYSIS
1.

[CORPORATION]’s Tennessee taxable income for the short period ending in [YEAR]

The net operating loss arising from [CORPORATION]’s deemed asset sale under Section
338(h)(10) was properly reflected in [CORPORATION]’s Tennessee taxable income on its
franchise and excise tax return for the short period ending in [YEAR]. (This loss will hereafter
be referred to as the “[YEAR] NOL.”)
Tennessee imposes an excise tax on the “net earnings” of certain persons, including corporations,
doing business within Tennessee. Tenn. Code Ann. §§ 67-4-2007(a) and 67-4-2004(29). 2 Tenn.
included in the consolidated tax return of the selling group, and no gain or loss is recognized on the sale of T’s stock
by members of that group.
2

The Tennessee franchise and excise tax laws have been recodified since the date of the transaction at issue. The
Tennessee Code Annotated references used herein will reflect the current code sections, unless there is a need to
note a change in the law that would have an impact on the answers to the questions presented.

2

Code Ann. § 67-4-2006(a)(1) defines the “net earnings” or “net loss” of a corporation as “federal
taxable income or loss before the operating loss deduction and special deductions provided for in
26 U.S.C. §§ 241-247 and 249, and as adjusted by subsections (b) and (c) of this section.”
Subsections (b) and (c) of Tenn. Code Ann. § 67-4-2006 require specific addition and subtraction
adjustments to federal taxable income to arrive at Tennessee taxable income. Subsections (b) and
(c) do not provide, however, for an adjustment to federal taxable income that would require gain
or loss arising from a Section 338(h)(10) election to be treated for Tennessee excise tax purposes
in a manner that is inconsistent with the federal income tax treatment.
The [YEAR] NOL was included in [CORPORATION]’s separate company federal taxable
income. In the computation of its Tennessee taxable income, [CORPORATION] is not required
to adjust its federal taxable income with respect to gain or loss arising from a Section 338(h)(10)
election. Therefore, the [YEAR] NOL was properly included in [CORPORATION]’s Tennessee
taxable income.
2.

Carry forward of [CORPORATION]’s [YEAR] NOL

[CORPORATION] may carry forward the [YEAR] NOL to subsequent tax periods for
Tennessee excise tax purposes.
Tenn. Code Ann. § 67-4-805(c)(i), applicable to [CORPORATION]’s [YEAR] short period
return, permitted a corporation to deduct a net operating loss from its net earnings in the
computation of its Tennessee excise tax liability; the corporation could carry forward and deduct
net operating losses for up to fifteen years. Additionally, Tenn. Comp. R. & Regs. 1320-6-1-.21
(“Rule 21”) (also applicable to [CORPORATION]’s [YEAR] short period return) provides that
each corporation is considered a separate entity, and that “in the case of mergers, consolidations,
etc., no loss carryovers incurred by the predecessor corporation will be allowed as a deduction
from net earnings on the tax return of the successor corporation.” 3
Accordingly, [CORPORATION] may carry forward the [YEAR] NOL if, after the transaction
that was the subject of the Section 338(h)(10) election, [CORPORATION] is either the same
taxpayer or the successor taxpayer for Tennessee franchise and excise tax purposes.
For federal income tax purposes, if a Section 338 election is made, the [CORPORATION]
corporation is treated as though it were two separate corporations, Old [CORPORATION] and
New [CORPORATION]. 26 U.S.C. § 338(a). In a Section 338(h)(10) election in particular, Old
[CORPORATION] is treated as if, before the close of the acquisition date, after the deemed asset
sale, and while Old [CORPORATION] is a member of the selling consolidated group, it
transferred all of its assets to members of the selling consolidated group and ceased to exist.
Treas. Reg. § 1.338(h)(10)-1(d)(4). Members of the selling consolidated group are treated as if,
after the deemed asset sale and before the close of the acquisition date, they received the assets
transferred by Old [CORPORATION]. Treas. Reg. § 1.338(h)(10)-1(d)(5)(i). In other words,
immediately after the deemed asset sale, Old [CORPORATION] is treated as having liquidated
3

The revision and recodification of the excise tax statute after the date of the transaction at issue incorporated Rule
21 into the net operating loss provisions under Tenn. Code Ann. § 67-4-2006(c). Tenn. Code Ann. § 67-4-2006(c)(1)
permits a taxpayer to deduct a net operating loss from its net earnings in the computation of its Tennessee excise tax
liability; qualified net operating losses may be carried forwarded and deducted for up to fifteen years. Tenn. Code
Ann. § 67-4-2006(c)(2) provides that each taxpayer is considered a separate entity, and that in the case of mergers,
consolidations and like transactions, a loss carryforward may be taken only by the taxpayer that generated it.

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into its parent company or companies. New [CORPORATION] is treated as a separate
corporation that acquired the assets of Old [CORPORATION].
The deemed existence of two [CORPORATION] corporations, and the deemed liquidation of the
old [CORPORATION] corporation, are a fiction created under federal income tax regulations.
The Tennessee Court of Appeals has stated, however, that “rulings of the federal courts in regard
to federal tax laws are not binding on Tennessee courts when they are called upon to interpret
Tennessee tax laws.” Little Six Corp. v. Johnson, 1999 WL 336308 at *3 (Tenn.Ct.App. May 28,
1999); See Tidwell v. Berke, 532 S.W.2d 254 (Tenn.1975). Therefore, the federal income tax
regulations do not control the determination of whether [CORPORATION] is the same taxpayer
or the successor taxpayer for Tennessee franchise and excise tax purposes.
The Tennessee franchise and excise tax laws do not provide for an election to treat a stock sale as
a deemed asset sale. Additionally, Tennessee has not adopted Section 338(h)(10) and the
accompanying federal regulations for purposes of Tennessee tax law. While it is true that, in the
computation of Tennessee taxable income, Tenn. Code Ann. § 67-4-2006(b)-(c) does not require
an adjustment to federal taxable income with respect to the Section 338(h)(10) election, the lack
of such a requirement is not the equivalent of the adoption of the underlying federal rule.
Because Tennessee has not adopted the federal regulations under Section 338, there is no
deemed existence of two [CORPORATION] corporations and no deemed liquidation of the old
[CORPORATION] corporation for Tennessee franchise and excise tax purposes. Additionally,
[CORPORATION] did not actually terminate its existence and liquidate into its parent as part of
the transaction that was the subject of the Section 338(h)(10) election. Finally,
[CORPORATION] is not a successor corporation as that term is used in Rule 21 and Tenn. Code
Ann. § 67-4-2006(c)(2), because [CORPORATION] did not merge or consolidate into another
corporation.
[CORPORATION] is therefore the same corporation before and after the transaction that was the
subject of the Section 338(h)(10) election. [CORPORATION] is the corporation that filed the
Tennessee franchise and excise tax return that generated the [YEAR] NOL. Accordingly, Tenn.
Code Ann. § 67-4-805(c)(i), Tenn. Code Ann. § 67-4-2006(c)(2) and Rule 21 permit
[CORPORATION] to carry forward the [YEAR] NOL to subsequent tax years for Tennessee
excise tax purposes.

Kristin Husat
Tax Counsel

APPROVED:

Loren L. Chumley
Commissioner of Revenue

DATE:

7/10/06

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