368(a)(1)(F) reorg impact?

September 21, 2023

by a searcher from The University of Chicago - Booth School of Business in Chicago, IL, USA

I am negotiating an LOI and one of the <20% owners may roll equity and stay under the 20% threshold to avoid a PG on the SBA 7a debt. To make the equity roll more tax efficient, the sellers proposed executing a 368(a)(1)(F) reorganization to an LLC pre-close. They are taxed as an S-corp today.

What, if any, impact may this reorg have on me as the buyer?

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Reply by a professional
from Walsh College of Accountancy and Business Administration in Detroit, MI, USA

Using an F-Reorg has pros and cons depending on facts. A few pros - as a buyer you get a step up in the tax basis of the assets and the seller has tax deferral on the <20% not sold. Sellers may also benefit from passthrough entity tax election(s) depending on the state(s) they file in. However, since the seller will own more than 20%, you need to make sure the section 197(f)(9) anti-churning rule does not apply. If it does, then there is some work to do in order to fall within one of the exceptions.

Reply by a professional
from Dartmouth College in Los Angeles, CA, USA

If done right in consultation with the right tax advisers it can give you the tax benefit of an asset sale. Seller should bear the risk that it is done correctly. From buyer perspective, it increases the complexity of the deal and makes it more expensive on fees, though not by that much. But it allows you to avoid assigning certain contracts/licenses and you can keep the operating history of the business. Downside is that you assume the liabilities of the operating business as in a standard stock sale.

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