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.

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).  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.  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.  The usual manner to implement a DE is commonly called a “dropdown.” 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.  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.  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.  Assuming all other criteria are met, this is typically deemed to be a valid F-reorganization under Revenue Ruling 64-250.  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.

This article was originally written by Vince Eget and published on the website of Bennett Thrasher, an Atlanta-based, full-service certified public accounting and consulting firm.  You can reach Vince at veget@btcpa.net or 770.396.2200.