Is anybody able to explain in simple terms what F Reorganization is on a stock deal?

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August 13, 2024

by a searcher from Charles Sturt University in New Jersey, USA

Is anybody able to explain in simple terms what F Reorganization is on a stock deal, what is the process and when should it be performed (I.e. before or after closing)? Is this something CPA can help with or attorney?

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Reply by a professional
from University of Michigan in Detroit, MI, USA
The technical answer is an F reorg is a mere change in identity, form, or place of organization. Does that answer your question? Of course not.

The primary advantage of an F reorg is flexibility. For example, the seller may be able to have the transaction taxed as a stock sale, while the buyer may be able to have it treated as an asset sale for tax purposes. This flexibility comes at the cost of increased complexity and expense.

In the context of a deal, here is a rough outline of how it may play out: (1) The shareholders of an S corp. (the Target) form a holding company (the Company); (2) the shareholders file elections to treat the Target as an S corp.; (3) the shareholders contribute their shares in the Company to the Target in exchange for the Target's shares; (4) the Company files elections to treat the Target as a “qualified subchapter S subsidiary," and the Target becomes a disregarded entity; (5) following the above but prior to closing, the Target is converted into a limited liability company and continues to be a disregarded entity, with the Company becoming the sole member; and (6) the buyer buys the Target's equity from the Company, but treats the sale as an asset sale for tax purposes.

If that sounds complicated, it is. And you should definitely work with a tax attorney if considering an F-reorg as part of your transaction.

On that note, a disclaimer: I am an M&A lawyer, not a tax attorney (the above is not legal advice). We have a tax lawyer on staff and work hand in hand with her on all tax matters. Don't scrimp on competent tax advice! It is well worth the expense.

Let me know if you want to discuss further. Always happy to help. DM me here or reach out directly at redacted
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Reply by an investor
from University of Pennsylvania in Charlotte, NC, USA
To add on while waiting for a tax expert to contribute. There is indeed a huge amount of bad information online with even some CPAs and law firms' websites saying the seller gets stock sale tax treatment. Fortunately, there are some credible and reliable information sources: The following is from an AICPA podcast with an EY tax partner who heads their sub S unit: "From the newco S corp. perspective we set up, they're treated as selling each underlying asset of the single-member LLC. Just like with an (h###-###-#### election] they will be treated as if they sold the assets. So there might be a mix of ordinary income, capital gain, and they should get compensated for that." See https://www.journalofaccountancy.com/podcast/s-corps-rev-rul###-###-#### f-reorganizations.html There are multiple reasons why a F reorg has become the preferred alternative to a 338 or 336 election - usually in my experience it comes down to rollover equity and/or fear of an invalid S - but not the seller getting tax treatment as in a stock sale.
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