I S S U E 2 , 2 0 2 2 20 nebraska cpas S CORPORATION INVERSION USING AN “F” REORGANIZATION BY HANNAH FISCHER FREY & JESSE SITZ, BAIRD HOLM LLP Many new business owners are excited by the f low-through treatment of income and loss as well as the selfemployment tax savings that can be available to entities that elect to be taxed under Subchapter S of the Internal Revenue Code of 1986, as amended (the “Code”). Such savings, which stem from the bifurcation of salary versus distributions, can be reason enough to make such an election, from an economic perspective. There are several downsides, however, to making an “S” election that business owners should consider prior to making such an election. Restrictions on the types of owners, classes of stock, and numbers of owners, among other things, can limit a business that wishes to sell or take on investors in the future. This can be particularly problematic to a business that is being acquired by a larger venture. Such acquisition entities, potential investors, or private equity firms are almost always organized as entities. The S corporation rules generally do not allow entities (except for very limited types) to own S corporation stock. Fortunately, there is an IRS-approved method by which an S corporation can reorganize itself to allow for an investment or acquisition of less than all of the stock by an entity. An “F” reorganization effectively allows the entity to admit an entity investor without jeopardizing the S election of the S corporation.1 This kind of reorganization is commonly referred to as an “S corporation inversion” or “F” reorganization, gaining its name from the Code Section from which it arises—Section 368(a)(1) (F). Lastly, this article provides a summary overview of the steps and rules regarding an “F” reorganization. There are many traps for the unwary. We recommend that careful diligence, documentat ion of the steps sat i sf ying the requi rement s summarized below, and coordination between the attorney and accountant all occur prior to undertaking such a reorganization. A. Steps for “F” Reorganization For purposes of this explanation, we will use the following terms: • Operating Entity – This refers to the original entity, which is taxed as an S corporation. • NewCo – This is the new entity, which will become the holding company of the Operating Entity. • QSub – This refers to a “qualified subchapter ‘S’ subsidiary” as defined in Section 1361 of the Code.
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