In the context of an S Corporation selling target, one of the most effective and popular tax planning techniques currently available to a buyer party seeking asset sale tax treatment optimization involves the combination of a pre-sale of F reorganization in conjunction with application of the one-day note concept into the final deal arrangement. To achieve the optimum tax results, the tax planning technique calls for the implementation of the following sequence of steps:
Step 1: Adopt a plan of reorganization and conduct a pre-sale F reorganization. This will change the current tax structuring of the S Corporation selling target to a disregarded entity status. The former S corporation selling target will now be wholly owned by the newly created S Corporation Holding Company. For more information on the benefits of consummating an F reorganization, please read the blogs, “Handling Deferred Revenue When Selling Your Business,” “M&A Tax Shop Talk – F reorganization,” and “Accrual Basis Is King When Selling Your Business.“
Step 2: Before entering the asset sales transaction, execute a plan of liquidation to be consummated by the selling shareholders within 12 months after closing. The distribution of the one-day note obligation, discussed in step 3, and the earn-out and escrow hold back components, if applicable, will not be taxable to the beneficial selling shareholders until the underlying funds are constructively received post-closing. Hence, the selling shareholders under the installment sale provision rules will step into the shoes of the liquidating S Corporation Holding Company.
Step 3: Negotiate and incorporate the one day note application concept into the final transaction arrangement. For more information of the benefits of using the one-day note application concept, please read “M&A Shop Talk: Tax Planning Using One-Day Note Concept Application.”
It is important to keep in mind that, for income tax reporting purposes, the selling shareholders do not physically need to dissolve the newly created S Corporation Holding Company, created in step 2, in order to achieve liquidation status. Additionally, the one-day note application use will never prevent the immediate taxability at closing of any built-in gains attributable to hot asset items. This includes all unrecognized cash basis deferral items, all pre-sale instalment sale deferred net profit, all advance payment received and deferred under the accrual, deferral method, and all unrecognized net profit from long-term contracts being deferred under the completed contract method.
If you are interested in scheduling an initial consultation on how to effectively structure the sale of your business, please contact Jorge Rodriguez, Aronson’s Tax Partner specializing in M&A specialized services for middle market businesses, at 301.222.8220 or email him at firstname.lastname@example.org.