Selling Your S Corporation? Why the F Reorganization Should Be Your First Conversation.

When a closely held business comes to market, the structure of the transaction can be just as 

important as the purchase price. For the large number of privately held businesses operating as S 

corporations, this is especially relevant. It is no secret that buyers and sellers frequently enter 

into negotiations with competing tax objectives. Without intentional planning, it is inevitable that 

one side will bear a disproportionate cost. A pre-transaction restructuring strategy known as an F 

reorganization offers a well-established path to aligning both parties’ interests by allowing the 

transaction to be treated as an equity sale for legal purposes while being treated as an asset sale 

for income tax purposes.  

S Corporation Landscape 

For federal tax law purposes, S corporations, one of the most popular structures for closely held 

businesses, are pass-through entities, meaning all income, losses, deductions, and credits flow 

directly to the owners and are taxed only once at the individual level, thus avoiding the double 

taxation of C corporations. While S corporations are more tax efficient than C corporations, to 

maintain S corporation status, an entity must satisfy strict eligibility requirements, such as being 

a domestic corporation or limited liability company (“LLC”), having no more than 100 owners, 

having only one class of equity, and being owned entirely by individuals, certain estates, and 

specific types of trusts. Partnerships, C corporations, LLCs, and non-resident aliens (“Prohibited 

Owners”) cannot be owners of an S corporation. These restrictions create a significant structural 

problem when private equity groups and other Prohibited Owners seek to purchase the equity of 

an entity taxed as an S corporation (“Target”), as a direct equity purchase by a Prohibited Owner 

would automatically terminate Target’s election to be taxed as an S corporation, thereby 

triggering unintended and unwanted tax consequences. The F Reorganization bridges this gap 

and creates a solution.  

The Core Tension between Buyers and Sellers 

When sellers enter into a transaction, they prefer to sell their equity in Target rather than Target’s 

underlying assets. Typically, an equity sale results in capital gains treatment on the sales 

proceeds and eliminates the burden of re-titling assets, assigning contracts, and transferring 

licenses and permits. An equity sale also allows Target to retain its historic employer 

identification number (“EIN”) and allows Target Employees to remain employed by the same 

entity so that payroll, benefits, and retirement accounts all continue without any interruption.  

When buyers enter into a sale, they almost always prefer an asset purchase, most notably for tax 

reasons. In an equity acquisition, the buyer typically inherits the selling entity’s historic tax basis 

in its assets, with no step-up in basis. In an asset purchase, the buyer gets a step-up in the basis of 

the selling entity’s assets equal to the amount paid for such assets, which is typically more than 

the selling entity’s historical basis, meaning that the buyer can receive much larger depreciation 

and amortization deductions, thus significantly lowering future income. This step-up in basis 

directly reduces taxable income in the years following the acquisition, creating a meaningful 

economic benefit for buyers, particularly in the early years following an acquisition when 

improving cash flow and financial performance are top priorities. The F reorganization delivers 

that step-up in basis to buyers while giving sellers the flexibility and benefits of structuring the 

transaction as an equity purchase.  

What is an F Reorganization? 

An F reorganization is a tax-free restructuring strategy defined by Section 368(a)(1)(F) of the 

Internal Revenue Code as “a mere change in identity, form, or place of organization of one 

corporation, however effected.” Despite its simple statutory definition, to qualify for tax-free 

treatment, the F reorganization must meet specific criteria, including that the same persons own 

the equity in both Target and the new entity (“Newco”) in identical proportions and that Newco 

initially hold no assets. When properly executed, no gain is recognized, the S corporation 

election remains valid, and Newco, the sole owner of Target, is treated as a continuation of 

Target for federal tax purposes.  

How an F Reorganization Works  

The mechanics of an F Reorganization in the context of a sale of equity in an S corporation may 

appear straightforward, but the sequencing is critical to its execution. First, the Target owners 

(“Owners”) form Newco, which is taxed as an S corporation, and then contribute 100% of their 

equity in Target to Newco in exchange for 100% of the Newco equity. Second, Newco files an 

election to treat Target as a qualified subchapter S subsidiary (“QSub”), thereby treating Target 

as a disregarded entity for federal tax purposes. Importantly, even though Target is now a QSub 

of Newco, Target retains its historic EIN. Third, if Target is organized as a state law corporation, 

it converts to an LLC under applicable state law. This conversion has no federal income tax 

consequences, but its timing is vital (it must occur at least one day after the QSub election to 

preserve corporate status). By the end of the F reorganization process, the Owners own 100% of 

Newco, which is taxed as an S corporation, and Newco owns 100% of Target, a disregarded 

entity.  

A buyer can now acquire Target’s equity from Newco, with the purchase price flowing through 

Newco to the Owners, and the buyer is treated, for federal income tax purposes, as if it purchased 

Target’s assets, resulting in a full step-up in the tax basis of Target’s assets in an amount equal to 

the purchase price. 

Conclusion  

For anyone navigating the sale or acquisition of an S corporation, the F reorganization strategy 

should be among the first structures on the table. Although the F reorganization is a popular and 

frequently used structure, it is a sophisticated tax strategy that demands careful planning, proper 

sequencing, and precise coordination between legal and tax counsel in order to work as intended. 

For more information on how an F reorganization may benefit your transaction, please contact 

our experienced transactional attorneys at Plunk Smith, PLLC. 

About Plunk Smith, PLLC

At Plunk Smith, PLLC, we provide personalized, result-driven legal counsel tailored to meet the unique needs of our clients. From businesses navigating complex transactions to individuals seeking estate planning advice, our team is here to guide you every step of the way and help you eliminate conflict.

About Adam Plunk

Adam Plunk is the Managing Partner of Plunk Smith, PLLC, where he advises business owners, entrepreneurs, and high-net-worth individuals on the legal matters that shape and protect their businesses. His practice includes mergers and acquisitions, business and corporate law, estate planning, governance, executive compensation, asset protection, and strategic transactions.

In addition to his corporate practice, Adam represents private equity, venture capital, and real estate funds on fund formation, management, and investment matters.

A native of East Texas, Adam earned his undergraduate degree from Albion College and his J.D. from DePaul University College of Law. Outside the office, he enjoys spending time with his family, golfing, hunting, following the Dallas Cowboys and Michigan Wolverines, and giving back to his community.

Partner Highlight: Plunk Smith, PLLC

A successful business transition requires more than finding the right buyer—it requires the right legal team to protect your interests every step of the way. That's why NorthStar is proud to partner with Plunk Smith, PLLC.

Led by Adam Plunk, Partner and CEO, the firm provides strategic legal counsel for mergers and acquisitions, corporate transactions, business succession planning, estate planning, and asset protection. Their business-first approach helps owners navigate complex legal decisions while preserving value and preparing for what's next. Plunk Smith works closely with business owners, executives, and investors to structure transactions, mitigate risk, and support successful outcomes.

We're grateful to have Adam and the Plunk Smith team as trusted members of our Transition Team, helping business owners move forward with confidence.