How an F reorganization can benefit the sale of an S corporation


by William E. Sigler   |   Michigan Bar Journal


 Although the Tax Cuts and Jobs Act of 2017 reduced the C corporation tax rate to 21%,1 S corporations remain one of the more popular vehicles for conducting business. In fact, it is not uncommon even for limited liability companies to make S corporation elections. When it comes time to sell an S corporation, conventional wisdom says that the buyer will want to purchase the business’s assets. But that is not always the case.

There can be reasons the buyer would prefer to purchase the equity of the business but have the transaction treated as an asset purchase for tax purposes. In those circumstances, the buyer will generally need to choose between a Section 338(h)(10) election,2 a Section 336(e) election,3 or an F reorganization.4 Among the alternatives, an F reorganization can offer important advantages.


Even though sellers of S corporations do not have to worry about two levels of taxes, they generally prefer to dispose of their businesses as a whole — along with the liabilities — by selling stock and paying tax on the proceeds at capital gains rates. Assuming no issues surface during the due diligence process, the buyer may also prefer to buy stock.

From the buyer’s perspective, purchasing stock can have several important advantages. It avoids complications involved with transferring trade names, contracts, licenses, and permits and allows for continuation of the seller’s employer identification number. In addition, it can facilitate transactions where the buyer wants the seller to have skin in the game in the form of equity after the sale closes.

The principal problem buyers face in a stock sale is the inability to obtain a fair market value tax basis for the assets inside the corporation for depreciation purposes.

One solution is for the buyer to make a Section 338(h)(10) election. This allows a buyer of stock in an S corporation (or a C corporation that is part of a consolidated group) to treat the transaction as an acquisition of 100% of the assets of the seller for tax purposes. A Section 336(e) election is similar to a 338(h)(10) election. However, to make a 338(h)(10) election, the buyer must be a corporation. Therefore, individuals, partnerships, and other non-corporate entities that otherwise cannot benefit from a 338(h)(10) election may be able to qualify for a 336(e) election, but there are important limitations with respect to these elections.

In a 338(h)(10) election, the buyer must acquire at least 80% of the total combined voting power of all classes of the seller’s stock entitled to vote and at least 80% of the total value of the stock.5 A similar requirement must be satisfied for a 336(e) election.6 These requirements can be a problem if the buyer wants the seller to roll over more than 20% of their proceeds into the purchasing entity after the acquisition is completed, particularly if the Internal Revenue Service on audit may disagree with the valuation of the stock and argue that the requirements for the 338(h)(10) or 336(e) elections were not met.

Another concern for the buyer is the validity of the seller’s S corporation election. To make a 338(h)(10) election, the seller must be a corporation that is a subsidiary in a consolidated group, a corporation that is a subsidiary eligible to file a consolidated return but chooses not to, or an S corporation7. To make a 336(e) election, the seller must be a domestic corporation that makes a “qualified stock disposition” of stock of another corporation.8 If a transaction qualifies under both code sections, then 338(h)(10) takes precedence.9 Thus, if 338(h)(10) is controlling but the seller’s S corporation status has knowingly or unknowingly terminated, the 338(h)(10) election will be ineffective and the buyer will not obtain a fair market value basis in the seller’s assets.


An F reorganization can be used to mitigate the risk of the seller having lost its S corporation election. There is no minimum amount of the seller’s stock that must be acquired in the transaction and no limitation on the amount of the proceeds received by the seller that can be reinvested in the purchasing entity.

Section 368(a)(1)(F) describes an F reorganization as a “mere change in identity, form, or place of organization of one corporation, however effected.” Historically, F reorganizations have been used to effectuate the following:

A change in a corporation’s name;

A change in the form of a corporation, such as from a business trust taxable as a corporation to a state law corporation; or

A change in a corporation’s state of incorporation, accomplished by having the corporation merge into a new corporation organized in the desired state of incorporation.

Six requirements must be met to qualify as an F reorganization. These requirements are:

  1. The buyer’s stock must be distributed in exchange for the seller’s stock.10 The goal of this requirement is making sure that both the buyer and seller have essentially the same stockholders. An exception exists for a de minimis amount of stock issued by the buyer other than in respect of the stock of the seller to facilitate the organization of the buyer or maintain its legal existence.
  2. The same persons must own all the stock of the buyer and seller in identical proportions.11 This requirement is not violated if the stock is of different classes or otherwise has different terms as long as it is of equivalent value, nor is this requirement violated if cash or other property is distributed from either corporation.
  3. The buyer may not hold any property or have any tax attributes prior to the F reorganization.12 This requirement is not violated if the buyer holds a de minimis amount of assets to facilitate its organization or maintain its legal existence, has tax attributes related to holding those assets, or holds proceeds of loans taken in connection with the F reorganization.
  4. The seller must completely liquidate as part of the transaction.13 A dissolution of the seller’s legal existence for state law purposes is not absolutely required for an F reorganization.14 The seller may even retain a de minimis amount of assets for purposes of preserving its legal existence.
  5. Immediately after F reorganization, no corporation other than the buyer may hold any property previously held by the seller if the other corporation would, as a result, succeed to any tax attributes of the seller under Section 381(c).15
  6. Immediately after F reorganization, the buyer may not hold property acquired from a corporation other than the seller if, as a result, the buyer would inherit tax attributes of the other corporation under 381(c).16

The fifth and sixth requirements were added to the final regulations in 2015 to further ensure that the buyer would be equivalent to the seller consistent with the definition of an F reorganization as a mere change in identity, form, or place of organization of one corporation.17


The steps of an F reorganization of an S corporation — and the timing of those steps — are based on Situation 1 in Rev. Rul. 2008- 18.18 A common plans is as follows:

  1. Create a new corporation on day one.19
  2. Contribute stock in the seller to the new corporation on day two.
  3. Make a Qualified Subchapter S Subsidiary (QSub) election on behalf of the seller by filing Form 8869 on day two.
  4. Convert the seller to an LLC on day three.20
  5. Sell the LLC to the buyer on day four.

F reorganization does not require that the seller have a valid S corporation election because the seller is selling a single-member LLC membership interest. There will be a step up in basis because for federal income tax purposes, the buyer is treated as purchasing the assets of the single-member LLC. Also, there are no limits on the amount of equity in the LLC that can be contributed via a partial rollover into the buyer’s acquisition structure with the remaining LLC equity being acquired by the buyer.

One pitfall to monitor concerns the QSub election. At the time the election is made, the seller must be a corporation.21 Therefore, the QSub election should be made at least one day before the state law conversion to an LLC. Otherwise, it may void the F reorganization.

There exists some controversy over whether a QSub election should be necessary in the first place. It isn’t referenced among the six requirements listed in the U.S. Department of Treasury regulations.22 Moreover, when a QSub election is made, the subsidiary corporation is deemed to have liquidated into the parent corporation.23 Likewise, when a corporation is converted into a single-member LLC, the corporation is deemed to have liquidated.24 Thus, the result is the same regardless of whether the QSub election is made.

The American Institute of Certified Public Accountants (AICPA) recently made this argument in a letter to the IRS. The AICPA also recommended that the IRS issue guidance confirming that a QSub election is not necessary and that when a subsidiary corporation is converted into an LLC as part of a reorganization occurring within a single day, the reorganization will be treated as an F reorganization and the subsidiary corporation will not be treated as a C corporation at any time during the reorganization.25


For buyers, an F reorganization of an S corporation can minimize the complications involved with transferring trade names, contracts, licenses, and permits commonly required with asset sales; permit the continuation of the seller’s employer identification number; and obtain a step up in the tax basis of the seller’s assets without concern about the validity of the seller’s S corporation election.

The seller, on the other hand, can defer gain recognition on the rollover equity and any deferred payments. The seller may not receive 100% capital gains treatment, but will dispose of the business as a whole including liabilities and, to the extent that the purchase price is not adjusted to reflect the seller’s taxes, the difference may be mitigated by other factors such as the availability of capital gains treatment on appreciated intangible assets.



1. Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, §13001, 26 USC 11 (2017).

2. I.R.C. §338(h)(10).

3. I.R.C. §336(e).

4. I.R.C. §368(a)(1)(F).

5. I.R.C. §338(d)(3).

6. Treas. Reg. §1.336-1(b)(6)(i).

7. Treas. Reg. §1.338(h)(10)-1(c)(1).

8. Treas. Reg. §1.336-1(b)(1).

9. Treas. Reg. §1.336-1(b)(6)(ii)(A) (Overlap with qualified stock purchase—(A).In general. Except as provided in paragraph (b)(6)(ii)(B) of this section, a transaction satisfying the definition of a qualified stock disposition under paragraph (b)(6)(i) of this section, which also qualifies as a qualified stock purchase (as defined in section 338(d)(3)), will not be treated as a qualified stock disposition.) (emphasis added).

10. Treas. Reg. §1.368-2(m)(1)(i).

11. Treas. Reg. §1.368-2(m)(1)(ii).

12. Treas. Reg. §1.368-2(m)(1)(iii).

13. Treas. Reg. §1.368-2(m)(1)(iv).

14. In PLR 200835002, the IRS held that the seller would be considered an ongoing corporation prior to its merger into the buyer in an F reorganization even though the seller had been dissolved for state law purposes as a result of its failure to continue filing its state-law business registration.

15. Treas. Reg. §1.368-2(m)(1)(v).

16. Treas. Reg. §1.368-2(m)(1)(vi).

17. I.R.C. §368(a)(1)(F).

18. Rev. Rul. 2008-18, 2008-1 C. B. 674; See also, PLRs 200542013, 200701017, and 200725012.

19. The buyer should be treated as an S corporation because of the S corporation election continuity rules in Rev. Rul. 64-250.

20. See MCL 450.4709 and Michigan Department of Licensing and Regulatory Affairs form CSCL/CD-554, “Certificate of Conversion”

21. IRC 1361(b)(3)(B).

22. Treas. Reg. §1.368-2(m)(1).

23. Treas. Reg. §1.1361-4(a)(2).

24. Treas. Reg. §301.7701-3(g)(1)(iii).

25. Blake Vickers, TaxNotes.com, AICPA Seeks More Guidance on Structuring F Reorganizations, https://www.taxnotes.com/research/federal/other-documents/ irs-tax-correspondence/aicpa-seeks-more-guidance-on-structuring-f-reorganizations/7h8g6 (posted August 29, 2023) (website accessed October 18, 2023).