USA – NEW YORK Trends and Developments Contributed by: Matthew Rappaport, Matthew Foreman, Michelle Kabel and Elysse Anderson, Falcon Rappaport & Berkman LLP
get Holding (and extends S corporation status to Target Holding, as per Rev. Ruls. 2008-18 and 64-250). Tax elections Three primary tax forms are associated with the F Reorganisation, each filed at a specific stage of the transaction. First, Target Holding will make a protective S election by filing IRS Form 2553. While making an S election for Target Holding is not technically required, it may prove administratively useful. Under Section 1.381 (b)-1 (a)(2), in the case of a qualified F Reorganisa - tion and without regard to whether such reorganisa - tion also qualifies under any other provision of Section 368 (a)(1), Target Holding is treated as Target would have been treated if there had been no reorganisation. Accordingly, a reorganisation under Section 368 (a)(1) (F) does not terminate the S election, which remains in effect for Target Holding. Nevertheless, a protective election may simplify administrative matters, particu - larly in states that request copies of IRS confirmation of S election status. Second, after the contribution of Target to Target Holding, Target Holding must file IRS Form 8869 to elect QSub status for Target. This election serves to extend S corporation status to Target Holding. Line 14 of Form 8869 should be marked “Yes” if the election is being made pursuant to a reorganisation under Sec - tion 368 (a)(1)(F) and Revenue Ruling 2008-18. Once the QSub election is effective, Target is treated as a disregarded entity for federal income tax purposes. Third, after Target undergoes a state law conversion or merger to become an LLC, Target Holding will file IRS Form 8832 to ensure Target is treated as a disregarded entity for tax purposes. This filing is not required when Target is already an LLC; however, a protective elec - tion could be useful as a method to update the IRS regarding the entity type and name change associated with the EIN. Conversion of Target through state law conversion or merger If Target is not already an LLC, it will become an LLC by way of conversion or merger. Some states have
conversion statutes, meaning Target can convert into an LLC by filing a form with the requisite state agency. For states that do not have conversion statutes, Target will become an LLC by way of a merger between Tar - get and a newly formed LLC. The merger requires the preparation of certain merger documents, such as a plan of merger and certificate of merger. Both merger documents will be filed with the requisite state agency, similar to jurisdictions with a conversion statute. Reasons to undertake an F Reorganisation The most common reason to undertake an F Reor - ganisation is when the target is an S corporation and the parties need to disregard the target entity with - out adverse tax consequences to facilitate a partial rollover transaction while obtaining a step-up in basis on the assets sold. Under Section 311 (b), when a corporation makes a distribution of its property, the corporation is required to recognise a gain as if it sold the appreciated property for fair market value; this includes tangible and intangible assets where the basis is likely zero, and therefore the entire amount constitutes a recognised gain. Notably, this treatment is one-sided, meaning that only gain is recognised, and no loss may be claimed. The objective of an F Reorganisation is to preserve pass-through treatment while avoiding termination of the S election, which would result in taxation as a C corporation. Another significant reason to pursue an F Reorganisa - tion is to grant equity to key employees or personnel in the form of a profits interest. S corporations cannot have multiple classes of stock, and all distributions must be made on a pro rata basis. Consequently, practitioners who wish to offer profits interests or oth - er classes of equity must form a partnership structure, which the F Reorganisation facilitates by converting the target into a disregarded entity held by a new hold - ing company. Conclusion The F Reorganisation under the Code is one of the most versatile and effective pre-transaction structur - ing tools available in M&A practice, particularly when the target entity is an S corporation. As this article has demonstrated, the F Reorganisation uniquely bridges the divergent tax preferences of buyers and sellers, enabling an equity acquisition for legal purposes while
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