Most small businesses , and even some attorneys , are unaware of this tax strategy , known as an election 338 ( h )( 10 ), which requires the owner to file a two-page form with the Internal Revenue Service . The process was explained in detail by Merle Erickson , a professor of accounting at the University of Chicago ’ s Booth School of

Acquirers are likely to realize the tax benefits of a step-up in basis whether or not they share them with the seller .

Business , at the Investments & Wealth Institute ’ s Strategy Forum 2024 on October 1 .

Erickson noted that only owners of S corporations can benefit from this election — yet these are the predominant business structures employed by many privately held companies . More than 80 % of businesses with more than $ 1 million in sales are either S corps , LLCs or partnerships . Acquirers are likely to realize the tax benefits of a step-up in basis whether or not they share them with the seller .

How does this work ? First , the sale of the business must be structured as an asset purchase . If it is structured as a stock swap — where the seller is compensated by receiving shares in the acquirer ’ s business instead of cash — the transaction is usually tax-free .

Erickson used the example of an Italian restaurant . Let ’ s say , for sake of simplicity , the owner carries its assets on the books at a value of $ 100,000 . If an acquirer offers $ 1.1 million for the restaurant , that increases the value of the assets , including the building , kitchen equipment and goodwill , by 1,000 %. In effect , the acquirer just bought another $ 1 million in tax deductions . Erickson explained that , if one depreciates the assets over five years , it can increase the present value of the acquired company by 20 %. The buyer then splits that extra 20 % with the seller , who enjoys the extra 10 % from the tax tactic .

That is , if the buyer tells the seller in the first place . The buyers might be perfectly happy to take advantage of sellers who don ’ t know about the revaluing of their assets , Erickson added . “ Uninformed sellers get nothing ” because the buyer is unlikely to educate them .

Indeed , he cited the example of a seller he met who used a lawyer unaware of election 338 ( h )( 10 ) when negotiating the sale of the seller ’ s business and effectively forfeited all of the tax benefits to the acquirer . ( The lawyer was supposedly a divorce specialist .) Erickson also pointed to an advisor in the audience who had used the 338 ( h )( 10 ) technique with several business owners . “ Clients should get a piece ” of the step-up in basis , he said .

One example of a private sale of a business that many advisors would be familiar with was the sale of Scottrade to TD Ameritrade . By using this technique , Scottrade was able to increase the price from three times revenues to 3.8 times revenues , Erickson said .

— Evan Simonoff

10 | FINANCIAL ADVISOR MAGAZINE | NOVEMBER 2024 WWW . FA-MAG . COM