Why is goodwill not tax-deductible in a plain stock acquisition, but it becomes deductible over 15 years in an asset acquisition or under a 338(h)(10) election? What does this imply for the after-tax cost of the acquisition?

In a stock purchase, the buyer is acquiring stock, not the underlying assets. The target's tax basis in its assets remains unchanged. Goodwill is not a separate tax asset; it simply represents the premium over identifiable net assets and has no tax basis. Only when there is an actual or deemed asset purchase does the buyer get a step-up in the tax basis of the assets acquired, and any excess purchase price over the fair value of identifiable tangible and intangible assets is allocated to goodwill for tax purposes. This tax goodwill is amortizable over 15 years under Section 197, providing annual tax deductions that reduce cash taxes. As a result, the after-tax cost of the acquisition is lower with a step-up. For example, a $100 million of tax-deductible goodwill generates $100M/15 = $6.67 million annual deduction, saving $6.67M * tax rate in cash taxes each year. The present value of those savings can be significant and often motivates the buyer to seek a 338(h)(10) election.

Follow-up pressure: (1) If the target is a C corp and a 338(h)(10) is not used, what is the typical structure to achieve a step-up, and what is the double taxation cost? (2) How would you calculate the breakeven purchase price increase a buyer would accept to obtain a 338(h)(10) election, given specific assumptions about cost of debt and tax rate? (3) Why might a seller reject a 338(h)(10) election even if the buyer offers a higher price?