Question

Suppose that Delta Airlines decides to acquire Jet Blue, whereby

Delta acquires all of the outstanding stock of Jet Blue for $3 billion in cash. The question
then is whether Delta should make a Section 338(g) election. Assume that the tax basis of Jet
Blue’s assets immediately prior to the acquisition is $2 billion and its liabilities are $500
million. For simplicity, assume any step-up in tax basis is allocated to assets that depreciate
for tax purposes over a period of 10 years using straight line, and that Delta faces a 21% tax
rate and a 10% discount rate. Assume that Jet Blue has $800 million of net operating loss
carryovers, and that because of Section 382 limitations, any acquired NOLs would have only
a small value to Jet Blue in subsequent years (for the purposes of the questions below you
can assume the NOLs have no value to Jet Blue other than reducing the tax cost of a 338
election).
What would be the tax cost of the 338 election?

Answer 1

The tax cost of a Section 338(g) election can be calculated by comparing the tax liabilities of making the election or not making it. It involves deducting the increase in asset value over a period of time and calculating the present value of the tax savings.

Step-by-step explanation:

The tax cost of a Section 338(g) election can be calculated by comparing the tax liabilities of the two options: making the election or not making it. In this case, if Delta acquires Jet Blue without making the Section 338(g) election, it will be taxed on any increase in the value of Jet Blue's assets in the future. On the other hand, if Delta makes the election, it will be taxed on the $3 billion purchase price of Jet Blue, but it will also be able to deduct the increase in asset value over a 10-year period. The tax cost of the 338 election is the present value of the tax savings resulting from the deduction, which can be calculated using the 10% discount rate and the 21% tax rate.