What it is
TL;DRAn F-reorg lets you slide a long-held S-corp underneath a new S-corp holding company tax-free, so a buyer can purchase the operating entity as an LLC (with a step-up in basis) while you keep your QSub election, EIN, and S-corp history intact.
On paper it sounds esoteric. In practice it is the single most common pre-transaction restructuring move in lower-middle-market deals, because buyers, strategic and private equity alike, almost always want the asset-purchase tax treatment of an LLC, while sellers want the capital gains and simplicity of selling stock.
The F-reorg bridges those two desires. The seller forms a new S-corp (NewCo), contributes the old S-corp (OldCo) stock to it, files a QSub election on OldCo, and then converts OldCo to a single-member LLC. From the buyer's perspective, it is buying an LLC whose assets get a basis step-up. From the seller's perspective, it is a stock sale taxed at capital gain rates.
Who it's for
F-reorgs are for S-corp owners contemplating any kind of liquidity event in the next 12-36 months, full sale, partial recap, ESOP, family transfer, or bringing in an outside investor.
- ✓S-corp with $3M+ enterprise value being marketed to PE or strategic buyers
- ✓Owner who wants to sell part of the company and roll the rest into the new structure
- ✓Long-held S-corp with significant goodwill that a buyer will want to amortize
- ✓Multi-shareholder S-corp planning a partial buy-out of one or more owners
- ×C-corp owners, wrong starting point; consider §338(h)(10) analysis instead
- ×Owners selling 100% for stock of a public acquirer (no benefit)
- ×S-corps under $1M enterprise value where transaction costs eat the savings
How it works
1. Form the new S-corp (NewCo)
Create a new state-law corporation, elect S-status on Form 2553 effective the day before the F-reorg, and adopt a tax year identical to OldCo's.
Shareholders of OldCo must mirror NewCo exactly in proportion and identity. Any deviation breaks the §368(a)(1)(F) safe harbor.
2. Contribute OldCo stock to NewCo
Shareholders contribute 100% of their OldCo stock to NewCo in exchange for NewCo stock. This is a §351 contribution layered under the F-reorg umbrella.
NewCo now owns 100% of OldCo, which remains a C-corp at the state level but is treated as a disregarded entity once the QSub election is filed.
3. File the QSub election on OldCo
File Form 8869 making OldCo a Qualified Subchapter S Subsidiary of NewCo, effective the same day as the contribution. OldCo is now a disregarded entity for federal tax purposes.
A QSub is treated as a division of its S-corp parent, not as a separate entity. All assets, liabilities, and items of income, deduction, and credit are deemed those of the parent.
4. Convert OldCo to an LLC
File a state-law conversion (or, in non-conversion states, a merger of OldCo into a new LLC). The LLC keeps OldCo's EIN, contracts, licenses, and trade name.
At closing, NewCo sells the LLC interests to the buyer. The buyer treats this as an asset purchase under Rev. Rul. 99-5, with a full step-up in basis on goodwill, equipment, and other assets.
A worked example
Marlene owns 100% of a 14-year-old S-corp distribution business in Cedar City, basis $200,000. A regional PE firm offers $8,000,000 for the business and insists on an asset purchase. Without an F-reorg, Marlene faces a forced asset sale at ordinary rates on the §1245 recapture plus a second layer of tax. With an F-reorg, Marlene sells stock of an LLC-converted entity and the buyer still gets the step-up.
| Direct asset sale (no F-reorg) | F-reorg → stock sale of LLC | |
|---|---|---|
| Sale price | $8,000,000 | $8,000,000 |
| Ordinary income on §1245 recapture | $1,400,000 | $0 |
| Capital gain on goodwill | $6,400,000 | $7,800,000 |
| Federal tax (blended) | ≈ $1,790,000 | ≈ $1,560,000 |
| Utah state tax | $390,000 | $390,000 |
| Federal tax saved | ≈ $230,000 |
Marlene clears roughly $230,000 more federal tax by selling NewCo stock instead of OldCo's assets, and the buyer gets exactly the deal it wanted. Documentation and legal cost: about $25,000.
Limits and risks
F-reorgs have to be executed in the right order, on the right date, with consistent shareholder mirroring. Skipping a single step, most commonly the same-day QSub election, collapses the tax-free treatment and the contribution becomes a taxable §351 with boot.
States vary. Most respect the federal treatment, but a few (California, Texas franchise tax, New York City) impose entity-level conversion fees or filing complications that affect timing.
If shareholders aren't identical at OldCo and NewCo (for instance, a trust owns part of OldCo but not NewCo), the structure fails. Trust beneficiary documentation has to be reviewed before, not during, the reorganization.
The IRS rarely audits the F-reorg itself, but it does audit the basis the buyer claims in the step-up. Sloppy purchase-price allocation, missing Form 8594, or inconsistent treatment between buyer and seller invites correspondence audits two to three years after closing.
IRS reference
- IRC §368(a)(1)(F)Defines an F-reorganization as a mere change in identity, form, or place of organization.
- Rev. Rul. 2008-18Roadmap for the modern F-reorg structure used in S-corp sales.
- Treas. Reg. §1.368-2(m)Six requirements for qualifying F-reorganizations.