Why Your F Reorg Should Happen Long Before Your LOI (Not the Week Before Closing)

Lost track of how many times a seller comes to me long into the deal and they explain, "As part of this transaction we agreed to do an F-free organization." The CPA and M&A had mentioned it months earlier, in passing, as something they'd "handle before closing."

Nobody had actually started it or fully understood, and punted it until another day.

That's the pattern I keep seeing with S corp sellers. The F reorg gets treated like a box to check on the way to the closing table, not a structuring decision that takes real lead time and real paperwork.

Here's the thing nobody tells you: the F reorg itself is a well-worn path under IRC Section 368(a)(1)(F). What's hard is everything the drop-down step forces you to confront about your own company, and you don't want to be confronting that three weeks before signing.

What an F Reorg Actually Does

An F reorg takes your existing S corp and drops it into a new structure. You form a new holding S corp (call it NewCo). You contribute your stock in the existing operating company (OldCo) to NewCo in exchange for NewCo stock. NewCo then elects to treat OldCo as a qualified subchapter S subsidiary.

Once OldCo is a QSub, traditionally it converts into a single-member LLC that's disregarded for federal tax purposes under the check-the-box regulations. That disregarded LLC is what your buyer actually acquires. 

The result under Rev. Rul. 2008-18: NewCo is treated as the same corporation that's always held your S election. Your buyer, meanwhile, gets a deemed asset purchase for tax purposes on the LLC interest they're buying, which usually means the stepped-up basis they want.

The Requirements That Actually Matter

Not every reshuffling of a cap table qualifies as an F reorg. The regulations under Section 368(a)(1)(F) lay out specific requirements, and missing one means you don't have a tax-free reorganization, you have a taxable transaction with a lurking tax bill waiting for you.

The shareholders of OldCo have to end up owning NewCo in the same proportions they owned OldCo. NewCo has to end up holding substantially all of OldCo's assets. And OldCo, in its pre-reorg form, has to be treated as liquidating into NewCo for tax purposes, even though nothing observable happens to the underlying business.

An attorney unfamiliar with the structure, the steps included, or the underlying tax law could miss a basic step, such as filing the Qsub election at the right time. Unraveling the whole structure leaves a seller with a nasty tax suprise.

The Paperwork Nobody Talks About

I hear it thrown around all the time, "just do an F Reorg," with some advisors thinking is an election, similar to a 338(h)(10) election or 336(e) election. It's not. A clean F reorg touches all of these:

Form SS-4 to get NewCo its own EIN. Form 2553 to make NewCo's own S election, filed early enough that there's no gap in S status. Form 8869 to make the QSub election for OldCo once it sits under NewCo. And (sometimes!) Form 8832, or a state-law conversion, to turn OldCo into the disregarded LLC that actually gets sold.

On top of the IRS filings, you need a Contribution Agreement documenting the stock-for-stock exchange, a Stock Power assigning the OldCo shares to NewCo, board and shareholder meeting minutes approving the whole plan.

If you manage to miss any portion of this, there could be continuity issues, which invariably raise red flags with the IRS.

Why the Drop-Down Is the Real Work

The part advisors gloss over is the drop-down itself: converting OldCo from an operating S corp into a disregarded LLC subsidiary. Doing that means someone has to look at everything sitting inside OldCo first.

Old subsidiaries nobody wound down. Related-party leases with your brother-in-law's LLC. Minority holders who never signed proper documentation, which also threatens the "same shareholders, same proportions" requirement above.

Reviewing what's in the S-Corp is incredibly important because we need to make sure that the tax election is preserved as part of the reorganization. Any issues with the S-Corp election? Qsub election is no longer valid. Qsub election is invalid? You get a big tax bill and a new C-Corp 

Why Timing Beats the Paperwork

If you start the F reorg after you've signed an LOI, you've already told the buyer a closing date. Now you're trying to untangle a related-party lease, sequence four IRS filings correctly, and track down a minority holder's signature, all on a deal clock you don't control.

Start it 60 to 90 days before you go to market instead. You'll find the same problems and file the same forms, but you'll do it on your own timeline, when a fix takes a phone call instead of a fire drill three days before closing.

That's the difference between an F reorg working the way the regulations intend and an F reorg becoming the thing that almost blows up your deal in the final week.

The Real Takeaway

The question isn't whether you need an F reorg. If your seller is going to market with an S corp, chances are high that your buyer will either force you into an asset sale or they will want you to undergo an F reorganization so that they can get deemed asset sale treatment. 

So the real question is whether you're treating it as a pre-sale structuring project with real sequencing (contribution, S election, QSub election, drop-down) or a closing-week formality your CPA mentioned once. Start it when you start thinking about selling, not when your buyer's lawyer asks for it. That single decision determines whether the drop-down surfaces problems you have time to fix or problems you have to explain away at 11pm the night before closing.

Until next time,

Josh