21 nebraska society of cpas W W W . N E S C P A . O R G Af ter the above steps are completed, NewCo should cause the Operating Entity to convert from a state-law corporation to a state-law limited liability company.3 Fol lowing such conversion, an ent ity investor could then purchase equit y interests of the Operating Entity without disqualifying the S election of NewCo. Upon such a purchase, the Operating Entity, of course, would no longer be an eligible QSub. Because the limited liabi lity company is a disregarded entity for income tax purposes, the purchase would be treated as an acquisition of assets of the limited liability company by the Buyer. Following the purchase, the limited liability company would be characterized as a partnership under the “check-the-box” rules. For example, if the Buyer acquires 70% of the interests of the Operating Entity, NewCo will recognize gain or loss as if NewCo had sold 70% of the assets of the Operating Entity to the Buyer. B. Documentation These steps must be memorialized in a written Plan of Reorganization, which would also specify the business purpose of the reorganization. Each party must f i le a requi red s tatement with thei r respect ive return under the Treasury Regulations for the tax year, which requires a report of the names and EINs of all parties to the reorganization; the date of the reorganization; and the aggregate fair market value of the assets, stock, or secur it ies of the Operat ing Ent ity transferred in the reorganization. C. Qual i f i cat ion as an “F” Reorganization The Treasury Regulations provide the following general requirements for an “F” reorganization under Section 368(a)(1)(F): 1. All of the stock4 of NewCo must be distributed in exchange for equity interests of the Operating Entity. 2. The same persons must own all of the equity interests of the Operating Entity immediately prior to the reorganization and of NewCo immediately after the reorganization, in identical proportions. 3. NewCo may not hold any property or have any tax attributes prior to the reorganization. 4. The Operating Entity must completely l iquidate for federa l income tax purposes in the reorganization but it is not required to dissolve under state law. This could include a deemed liquidation under the Section 7701 Regulations. 5. Immediately after the reorganization, no ent ity other than NewCo may hold property that was held by the Operating Entity immediately before the reorganization, if the other entity would succeed to the tax attributes. 6. Immediately after the reorganization, NewCo may not hold prope r t y acquired from anyone other than the Operating Entity, if NewCo would succeed to the tax attributes. Unl ike other tax-f ree reorganizat ions under Section 368, an “F” reorganization is exempt f rom the judicial ly created “continuity of business enterprise” and “continuity of interest” requirements. An “F” reorganization is not, however, exempt from the business purpose requirement. A summary of what constitutes a valid “business purpose” for purposes of Section 368 is beyond the scope of this article. With that said, business owners and The star t ing point may look l ike the following: First, the owners of Operating Entity organize a new ent ity (“NewCo”) as a state business ent ity that meets the requirements for qualification as a small business corporat ion. NewCo should not be capitalized, other than a nominal amount that may be required by state law for formation or incorporation.2 Second, the same owners contribute all of their equity in the Operating Entity to NewCo in exchange for ownership interests in NewCo. Th i r d , imme d i a t e ly f o l l ow i ng t he contribution, NewCo causes the Operating Entity to elect to be taxed as a qualified subchapter S subsidiary (“QSub”). This is an important step, the complexity of which is frequently overlooked. Shareholders Shareholders NewCo Operating Entity Operating Entity Buyer ← ← ← OldCo Stock OldCo Stock S Corp S Corp Q Sub Election NewCo Stock
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