An “F-reorganization” is a type of entity reorganization done primarily for tax purposes. It is a type of tax-free change under the IRS Code typically including a change in identity (i.e. name), or form of entity (LLC into a corporation). In order to realize the tax-free advantages, six requirements (set forth in the Treasury Regulations) must be followed. (See Treas. Reg 1.368-2 (m)(i) – (vi)).
The reorganization is relatively straightforward. The owner of an original company which is an “s” elected entity for tax purposes (“Entity A”) creates a holding corporation (“Entity B”) to become the “parent” and owner of all the equity of Entity A. Entity B then makes an “s” election for tax purposes. At this point, Entity B can make certain tax elections or cause Entity A to convert into another entity type.
F-reorganizations would most commonly be executed in connection with a sale of Entity A. Entity B directs Entity A to convert into an LLC designating Entity A as a disregarded entity for tax purposes (a “QSUB” election). This allows the buyer of Entity A to obtain certain tax advantages such as a step up in basis, and allows the seller to obtain capital gains treatment on the sale of equity (if applicable). Additionally, an f-reorganization is a very tax advantageous way to retain ownership if the seller wants to continue to be an owner in Entity A following the sale.
Understanding the tax advantages of an f-reorganization is especially important in structuring and evaluating a transaction.
Bottom Line: an “F-reorganization” is just a fancy way of giving both parties in a sale transaction tax advantages and can be seen in their growing popularity.
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