Publications
02.10.12
The Continued Evolution of the “F” Reorganization
“In 1940, Randolph Paul said that the Type F reorganization ‘is so little relied upon by taxpayers that this part of the statute has indeed perished through lack of use’ and, in 1954, the House proposed its repeal. It was retained in the 1954 Code, however, and came to play an unexpectedly important role. ” Simply defined, an “F” reorganization is “a mere change in identify, form, or place of organization of one corporation.” It is generally understood that an “F” reorganization involves the reorganization of one operating entity as opposed to, for example, a merger of two operating companies with one of those companies surviving the merger.
Quite often, middle market companies are structured as S corporations for federal income tax purposes. An S corporation itself is generally not subject to tax but the income or loss flows through the individual shareholders. From an M&A perspective, the buyer and seller can enter into an election to treat the sale of the stock of the S corporation as a sale/purchase of the assets; therefore, giving the buyer a step-up in the assets acquired while the seller still only has one level of gain. Suppose, however, that the seller wants to retain certain assets and distributing those assets to the shareholder prior to a sale would trip a gain. Accordingly, the seller does not want to sell enough of the stock such that the buyer and seller could make a sec. 338(h)(10) election and the seller does not wish to do an asset sale.
In PLR 20115016 the IRS ruled that a number of steps taken by an S corporation prior to an acquisition were a Type F reorganization and therefore tax deferred. The steps of the ruling are as follows:
- Shareholder (as the sole shareholder of OldCo, an S corporation) will create a new wholly owned corporation “NewCo”) under the laws of State.
- Shareholder will transfer all the stock of OldCo to NewCo in exchange for all of the stock of NewCo (the “Contribution”). Thus, OldCo will be a wholly owned subsidiary of NewCo and NewCo will be wholly owned by Shareholder.
- NewCo will make a QSub election for OldCo.
- OldCo will distribute to NewCo the Retained Assets.
NewCo intends to sell the stock of OldCo. Based on the representations made by the taxpayer and applying the step transaction doctrine, the IRS ruled that the contribution (step 2) coupled with the QSub election (step 3) are integrated such that it is a reorganization within the meaning of IRC § 368(a)(1)(F). OldCo’s S election “migrates” to NewCo; therefore, no new S election is needed and NewCo will be treated as an S corporation going forward. Since a QSub is generally disregarded for tax purposes, the distribution of the retained assets to NewCo is a non-event for federal income tax purposes. Finally, the sale of OldCo’s stock will be treated as the sale assets by NewCo for federal income tax purposes.
From the acquirer’s perspective, assuming acquirer is not an S corporation; the acquirer will be deemed to have purchased the assets and then transferred them to OldCo in a non-recognition transaction. As a result, the acquirer will obtain a step-up in the basis of the assets including intangibles for federal income tax purposes without having had to make a Section338(h)(10) election. If acquirer were an S corporation and made a separate QSub election for OldCo, the deemed liquidation of OldCo as a result of the new QSub election would be disregarded and acquirer would simply be deemed to have acquired the assets of OldCo in an applicable asset acquisition; again, negating the need for a Section 338(h)(10) election.
Although an F reorganization may make sense in this fact pattern, there could be other factors that would favor a Section 338(h)(10) election.
For any further information on any of the topics discussed herein please contact one of Argy’s transaction tax advisors.
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1Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, 12.28[2] (WG&L 2012)
2IRC § 368(a)(1)(F)
3See IRC § 1363
4See IRC § 338(h)(10); Treas. Reg. § 1.338(h)(10)-1(c)(1)
5A “QSub” is a 100% owned corporation for which an S Corporation can elect to treat such subsidiary as a “disregarded” entity for federal income tax purposes. See Treas. Reg. § 1.1361-2(a).
6See Rev. Rul. 2008-18, 2008-1 CB 674.
7See Treas. Reg. § 1361-5(b)(3), Ex. 9
8Id.
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