Exits & M&A · Brief · Pro level
Pre-sale F reorganizations for S corporations: why PE buyers insist on them
The F-reorg structure — new holding company, QSub election, LLC conversion — gives buyers asset-purchase tax treatment and rollover flexibility without betting the deal on the target's S election history.
Private equity buyers of S corporations have largely standardized on the pre-sale F reorganization, displacing the Section 338(h)(10) election. The structure delivers the same prize — asset-purchase treatment and a full basis step-up — while removing the election's two chronic risks: dependence on a valid, never-blown S election, and the requirement of a corporate buyer taking at least 80% for cash. It also happens to be the cleanest chassis for rollover equity.
The four steps
The sequence, executed days or weeks before closing: (1) shareholders form NewCo and contribute all target stock to it in exchange for NewCo stock, pro rata; (2) NewCo elects to treat the target as a qualified subchapter S subsidiary (QSub) on Form 8869, making the target disregarded; (3) the target converts to a single-member LLC under state law (or merges into one), which is a nonevent for tax purposes since it is already disregarded; (4) at closing, NewCo sells LLC interests to the buyer.
Rev. Rul. 2008-18 confirms the pattern qualifies as a reorganization under Section 368(a)(1)(F) — a "mere change in identity, form, or place of organization" — with NewCo continuing the target's S election (no new Form 2553) while, unusually, the target retains its historic EIN at the LLC and NewCo obtains a new one. Treas. Reg. §1.368-2(m) (see eCFR Title 26) supplies the six mechanical requirements, all easily met in the standard sequence.
At closing, the sale of 100% of the LLC interests is a purchase of assets by the buyer (Rev. Rul. 99-6 situation 2 dynamics on the buyer side); a sale of less than all, with the buyer vehicle taxed as a partnership, gives the buyer a Section 743-style result on the purchased portion while NewCo's retained interest continues. Either way NewCo reports asset-sale gain flowing through to shareholders once — the same single tax layer as a 338(h)(10), and the same character issues: recapture ordinary, goodwill capital, allocations per the Section 1060 classes.
Why buyers like it: the S election stops being a bet
A 338(h)(10) collapses if the target's S election was ever invalid — a disqualifying trust, a second class of stock lurking in an old side letter. In the F-reorg structure, the buyer's step-up rests on buying LLC interests, not on the election's validity; a blown S election changes the seller's tax result (NewCo might be a C corporation) but not the buyer's basis. Buyers still diligence S status — sellers bear real exposure — but the deal no longer dies on it. There is also no Form 8023, no 9-month election deadline, and no requirement that the purchaser be a corporation, which is decisive for fund buyers acquiring through partnership vehicles.
Rollover mechanics
The structure's second selling point is tax-efficient rollover. Because NewCo can sell, say, 75% of the LLC interests for cash and retain 25% alongside the buyer's partnership, the retained portion defers gain — contrast the 338(h)(10), where the deemed asset sale taxes 100% of the gain even on rolled equity. Where the buyer's topco is a corporation, the roll typically runs through Section 351 or a partnership interposed below; the paths, boot rules, and QSBS consequences are mapped in rollover equity taxation.
The F reorg does not make sense for targets whose licenses or contracts sit at the entity level and cannot survive an LLC conversion, for sellers who would net more keeping a stock sale (the buyer should pay a gross-up for the step-up here exactly as in an election deal), or where the deal timeline cannot absorb the pre-closing restructuring. And it is S corporation technology: C corporation targets get no single-tax benefit from it.
Frequently asked questions
- What is a pre-sale F reorganization of an S corporation?
- The shareholders form a new holding corporation, contribute the target's stock to it, elect QSub status for the target, and then convert the target to a single-member LLC. The sequence is a mere change in form under Section 368(a)(1)(F): the holding company inherits the S election and EIN continuity for tax purposes, and the buyer then purchases the LLC interests — a deemed asset purchase.
- Why do buyers prefer an F reorg over a 338(h)(10) election?
- Three reasons. The buyer need not be a corporation or acquire 80% at once, so partnerships and funds qualify and sellers can roll equity tax-deferred. The buyer's step-up does not depend on the target's S election having been valid — the sale of LLC interests is an asset purchase regardless. And no joint election or Form 8023 deadline is required.
- How does rollover equity work in an F-reorg deal?
- Because the buyer is purchasing LLC interests, the seller's holding company can retain a portion. If the buyer vehicle is a partnership, the retained interest is generally a tax-deferred continuation (or a Section 721 contribution); the seller recognizes gain only on the portion sold for cash. A 338(h)(10), by contrast, taxes 100% of the deemed asset gain even when sellers roll.