Tax Planning Technique Options & Scenario Summary Highlights

1. Asset Sale Using Tax-Free F Reorganization
Tax Planning Technique Options & Scenario Summary Highlights
authored by Jorge L. Rodriguez, CPA and Tax Partner specializing
in exiting transactions. Jorge can be contacted at 301.222.8220 or
email at jrodriguez@aronsonllc.com

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Introduction
Step 1: Form a new corporation
hereafter referred as “HoldCo”
Step 2: All the S corporation
shareholders (with no exception)
will contribute 100% of its
ownership to HoldCo. Need to
apply for a separate employer
identification number (EIN).
Step 3: Pursuant to IRS Revenue
Ruling 2008-18, the old S election
of the S Corporation will
automatically revert to HoldCo.
Step 4: Effective the same date as
Step 2, convert the S Corporation to
a Qualified Subchapter S
Corporation (QSub) by filing IRS
Form 8869 within 75 days. Entity
will retain old EIN.
Step 5: Convert the QSub still a
legal entity for state tax purposes to
an LLC via a formless conversion.
Entity will retain old EIN.
• The “F Re-organization” has become the perfect tax planning structuring platform
technique in today’s middle market M&A world involving asset sale transaction. The
basic structuring should be tax-free and it generally consists of the following sequence
of steps:
There might be some additional steps required if
for example; the S corporation is not organized
under a state that permits formless conversion
process to LLC form. Further, any S Corporation
that is subject to unrecognized Net Unrealized
Built-in Gains (NUBIG) tax under IRC Sec 1374
will not be triggered upon such conversion
process but it will become the legal responsibility
of the newly formed Hold Co.

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Option #1
• Scenario: Tax-Free “F” Reorganization conducted in conjunction with converting the selling target entity to a
Qualified Subchapter S Subsidiary (QSub) of newly formed S corporation parent company.
• Major Tax Summary Highlights:
– Ideal for an existing S Corporation selling target with; 1). multiple shareholders including option holder pool that
are contemplating an asset sale form exiting transaction and/or 2). change of control event involving deferred
compensation payout arrangements with key employees.
• With regards to multiple shareholders scenario involving a lot of hoopla to reach unanimous consensus, the F re-
organization structuring with the appropriate state jurisdiction will certainly eliminate such tension (i.e., certain
states only require consensus from the ultimate beneficial majority members selling the lower tier LLC
investment).
• With regards to maximizing the deductibility characterization component of certain payout customary transaction
items including option cancellation payments, the F –reorganization will provide the tax structure support to
substantiate ordinary trade or business expense characterization tax treatment (i.e., 20% tax benefit based on
current law).
– The conversion feature of the target to QSub status taxed as a disregarded entity for income tax reporting
purposes only (i.e. for state legal purposes including contract novation matters, etc., the QSub target is a legal
operating entity) will cut down tax due diligence scope, and will entirely eliminate asset sale tax elections related
compliance costs normally incurred with respect to effecting elections under IRC Sections 338(h)(10) or 336(e)
– For the record, our comments above are based on the assumption that the selling S corporation target
has an S election in effect for at least five full calendar years and thus the selling target is not subject to
built-in gains tax ramifications.

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Option #2
• Scenario: Tax-Free “F” Reorganization conducted in conjunction with converting the
selling target entity to a Qualified Subchapter S Subsidiary (QSub) (same as option 1)
and incorporating a 1-day note concept
• Major Tax Summary Highlights:
– Provides all features stated in Option #1 plus it provides optimal tax minimization for state
income tax reporting purposes and installment sale reporting.
• Ideal for pass-through selling shareholders that legally reside in tax heaven states such as
Florida, Nevada, Washington State, etc., and have established permanent, legal residence in
that particular state before entering into an exit transaction.
• Reduces the tension involving large non-resident withholding requirements and interaction
with hold-back provisions at closing because of multi-state reporting by the selling target
entity.
– For the record, to take advantage of this 1-day note planning feature, the Holding
Company created via the F Reorganization must be liquidated within 12 months after
adopting such plan of liquidation. The plan of liquidation must be adopted on or
before the closing date of the contemplated asset sale arrangement. Also there are
certain state taxing jurisdictions that do not conform to federal law with respect to
installment sale reporting involving 1-day note concepts.

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Option #3
• Scenario: Tax-Free “F” Reorganization conducted in conjunction with the ultimate conversion of
the selling target entity to a Single Member LLC Status via tax-free state sponsored formless
conversion statute provisions and either incorporating the 1-day note concept discussed in
Option 2 or instead, incorporating a partial equity rolled-over along with LLC freezing re-
evaluation technique to attract and retain talent
• Major Tax Summary Highlights:
– Provides all the features stated in Option #1 but the 1-day note tax planning concept incorporated under
Option #2 is not available if you want to incorporate an equity-rolled-over feature as discussed below.
• An equity rolled–over feature would be ideal for example if you are looking for a partial liquidity event
involving strategic incoming partner arrangement (i.e. a strategic private equity investment that will help
your current business model grow and evolve).
• The equity rolled-over tax treatment feature is created via the LLC interest portion component not sold to
incoming strategic investor.
– Furthermore, in conjunction with this re-structuring arrangement, you can also incorporate a revaluation
and freezing of your current equity appreciation technique at the LLC level and create a preferred equity
payout arrangement with an attractive IRR feature component.
• The re-valuation economic binding arrangement concept will provide liquidity protection having priority
payout to you and will create an optimal tax structure that will allow you to attract and retain key
employees with profit interest participation tied to future appreciation of the business model.

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General Disclaimer
The enclosed slide show presentation is solely intended to be
educational and it is not intended or written to be used, and it cannot be
used, for the purposes of avoiding federal and state income tax
imposition including the avoidance of the potential assessment of
interest and penalties thereof.