Asset Sale Using Tax-Free F ReorganizationTax Planning Technique Options & Scenario Summary Highlights authored by Jorge L. Rodriguez, CPA and Tax Partner specializing in exiting transactions. Jorge can be contacted at 301.222.8220 or

email at jrodriguez@aronsonllc.com

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Introduction

Step 1: Form a new corporation hereafter referred as “HoldCo”

Step 2: All the S corporation shareholders (with no exception)

will contribute 100% of its ownership to HoldCo. Need to apply for a separate employer identification number (EIN).

Step 3: Pursuant to IRS Revenue Ruling 2008-18, the old S election

of the S Corporation will automatically revert to HoldCo.

Step 4: Effective the same date as Step 2, convert the S Corporation to

a Qualified Subchapter S Corporation (QSub) by filing IRS Form 8869 within 75 days. Entity

will retain old EIN.

Step 5: Convert the QSub still a legal entity for state tax purposes to an LLC via a formless conversion.

Entity will retain old EIN.

• The “F Re-organization” has become the perfect tax planning structuring platform technique in today’s middle market M&A world involving asset sale transaction. The basic structuring should be tax-free and it generally consists of the following sequence of steps:

There might be some additional steps required if for example; the S corporation is not organized under a state that permits formless conversion process to LLC form. Further, any S Corporation that is subject to unrecognized Net Unrealized Built-in Gains (NUBIG) tax under IRC Sec 1374 will not be triggered upon such conversion process but it will become the legal responsibility of the newly formed Hold Co.

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Option #1

• Scenario: Tax-Free “F” Reorganization conducted in conjunction with converting the selling target entity to a Qualified Subchapter S Subsidiary (QSub) of newly formed S corporation parent company.

• Major Tax Summary Highlights: – Ideal for an existing S Corporation selling target with; 1). multiple shareholders including option holder pool that

are contemplating an asset sale form exiting transaction and/or 2). change of control event involving deferred compensation payout arrangements with key employees. • With regards to multiple shareholders scenario involving a lot of hoopla to reach unanimous consensus, the F re-

organization structuring with the appropriate state jurisdiction will certainly eliminate such tension (i.e., certain states only require consensus from the ultimate beneficial majority members selling the lower tier LLC investment).

• With regards to maximizing the deductibility characterization component of certain payout customary transaction items including option cancellation payments, the F –reorganization will provide the tax structure support to substantiate ordinary trade or business expense characterization tax treatment (i.e., 20% tax benefit based on current law).

– The conversion feature of the target to QSub status taxed as a disregarded entity for income tax reporting purposes only (i.e. for state legal purposes including contract novation matters, etc., the QSub target is a legal operating entity) will cut down tax due diligence scope, and will entirely eliminate asset sale tax elections related compliance costs normally incurred with respect to effecting elections under IRC Sections 338(h)(10) or 336(e)

– For the record, our comments above are based on the assumption that the selling S corporation target has an S election in effect for at least five full calendar years and thus the selling target is not subject to built-in gains tax ramifications.

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Option #2

• Scenario: Tax-Free “F” Reorganization conducted in conjunction with converting the selling target entity to a Qualified Subchapter S Subsidiary (QSub) (same as option 1) and incorporating a 1-day note concept

• Major Tax Summary Highlights: – Provides all features stated in Option #1 plus it provides optimal tax minimization for state income tax

reporting purposes and installment sale reporting. • Ideal for pass-through selling shareholders that legally reside in tax heaven states such as Florida, Nevada,

Washington State, etc., and have established permanent, legal residence in that particular state before entering into an exit transaction.

• Reduces the tension involving large non-resident withholding requirements and interaction with hold-back provisions at closing because of multi-state reporting by the selling target entity.

– For the record, to take advantage of this 1-day note planning feature, the Holding Company created via the F Reorganization must be liquidated within 12 months after adopting such plan of liquidation. The plan of liquidation must be adopted on or before the closing date of the contemplated asset sale arrangement. Also there are certain state taxing jurisdictions that do not conform to federal law with respect to installment sale reporting involving 1-day note concepts.

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Option #3

• Scenario: Tax-Free “F” Reorganization conducted in conjunction with the ultimate conversion of the selling target entity to a Single Member LLC Status via tax-free state sponsored formless conversion statute provisions and either incorporating the 1-day note concept discussed in Option 2 or instead, incorporating a partial equity rolled-over along with LLC freezing re-evaluation technique to attract and retain talent

• Major Tax Summary Highlights:– Provides all the features stated in Option #1 but the 1-day note tax planning concept incorporated under Option

#2 is not available if you want to incorporate an equity-rolled-over feature as discussed below. • An equity rolled–over feature would be ideal for example if you are looking for a partial liquidity event involving

strategic incoming partner arrangement (i.e. a strategic private equity investment that will help your current business model grow and evolve).

• The equity rolled-over tax treatment feature is created via the LLC interest portion component not sold to incoming strategic investor.

– Furthermore, in conjunction with this re-structuring arrangement, you can also incorporate a revaluation and freezing of your current equity appreciation technique at the LLC level and create a preferred equity payout arrangement with an attractive IRR feature component. • The re-valuation economic binding arrangement concept will provide liquidity protection having priority payout to

you and will create an optimal tax structure that will allow you to attract and retain key employees with profit interest participation tied to future appreciation of the business model.

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General Disclaimer

The enclosed slide show presentation is solely intended to be educational and it is not intended or written to be used, and it cannot be used, for the purposes of avoiding federal and state income tax imposition including the avoidance of the potential assessment of interest and penalties thereof.