Using F-Reorganizations Strategically in Mergers and Acquisitions Transactions
Avoiding problems with an SMLLC
This article reviews the benefits of considering the use of F-reorganization in mergers and acquisitions in addition to the more familiar disregarded entities (DEs) or single member limited liability company (SMLLC). F-reorganization can be used to overcome specific challenges, particularly as they relate to an SMLLC.
Many practitioners are familiar with the benefit of using disregarded entities (DEs) or single-member limited liability companies (SMLLCs) in structuring merger and acquisition transactions. However, advisors should also consider the advantages of using F-reorganizations to solve certain problems that can be encountered when forming a SMLLC.
An F-reorganization is a tax-free reorganization under IRC 368(a)(1)(F). Â It is typically defined as a mere change in identity, form,, or place of organization. An F-reorganization is very useful when the target-selling corporation has a business or tax reason to implement a DE, but there are impediments to forming a SMLLC. Â Common problems encountered when forming a DE can vary from obtaining legal consents, incurring transfer taxes, tax burdens under IRC 338(h)(10) sales, and regulatory hurdles such as deemed change in control in healthcare transactions. Â The usual manner to implement a DE is commonly called a â€śdropdown.â€ť A drop-down occurs when the target transfers assets/liabilities into a SMLLC. The F-reorganization can effectively achieve the same result as a dropdown while avoiding some of the negative consequences of a dropdown mentioned above.
A common example of using an F-reorganization would involve a transaction where the seller is an S-corporation. Â Assume further that the selling S-corp and buyer are considering making a IRC 338(h)(10) election or a drop down, but are faced with the rigidity of the election and obtaining hundreds of legal consents if a drop down is utilized. Â The F-reorganization action plan would have the shareholders of the S-corp form a new holding company and make a valid S-election, and the shareholders would contribute the shares of the selling S-corp to the new holding company. Â Assuming all other criteria are met, this is typically deemed to be a valid F-reorganization under Revenue Ruling 64-250. Â The holding company then makes a Q-sub S election for the S-corp subsidiary, and then make an election under state law to convert to an LLC. Thus, you now have the desired result of an S-corporation, which owns 100 percent of an LLC, without triggering any of the negative consequences of a dropdown. As stated earlier, this places the seller in a position where they can have flexibility to do the following:
- Avoid obtaining legal consents or incurring transfer taxes via a drop down.
- Be able to structure the sale of the LLC interests which avoids the rigidity of a 338(h)(10) election, including the requirements on greater than or equal to 80 percent sale, taxing the entire gain and meeting the qualified stock purchase requirements.
[author] [author_image timthumb=’on’]http://m.c.lnkd.licdn.com/mpr/mpr/shrink_200_200/p/5/000/1eb/3b6/2ff198b.jpg[/author_image] [author_info]This article was originally written byÂ Vince EgetÂ and published on the website ofÂ Bennett Thrasher, an Atlanta-based, full-service certified public accounting and consulting firm. Â You can reach Vince at firstname.lastname@example.org or 770.396.2200. [/author_info] [/author]