Do I have to agree to an F reorganization if my buyer asks for one?

No. It is a negotiating point, not a legal requirement, and the buyer needs your cooperation to do it at all. The right response is to price the character change first. Get your depreciation schedule and identify how much of the price will land in §1245 recapture at 37% instead of 20%, then ask for that difference grossed up in the purchase price.

Does the F reorganization itself trigger any tax?

No. A reorganization under §368(a)(1)(F) is tax-free, the shareholders recognize nothing on the exchange of stock, and under Rev. Rul. 64-250 the S election continues for the new holding company without a new Form 2553. Rev. Rul. 2008-18 adds that the old S corporation files no final return and keeps its EIN, while the new holding company obtains its own. The tax arrives with the sale, not the restructuring.

Will an F reorganization before a sale trigger an IRS audit?

The structure itself is routine and published. Rev. Rul. 2008-18 describes it, Form 8869 has a checkbox on line 14 specifically for it, and thousands of deals use it every year. What actually gets examined is the paperwork around it: whether the QSub election was effective immediately after the contribution, and whether the buyer and seller filed matching §1060 allocations on Form 8594. Inconsistent Forms 8594 draw more attention than the reorganization ever will.

What happens if Form 8869 is filed late?

The QSub election is generally made effective 2 months and 15 days before the date it is filed rather than on the date you wanted, which breaks the Rev. Rul. 2008-18 sequence and means the S election never carried over to the holding company. The IRS will accept a late election as timely on a showing of reasonable cause, and a private letter ruling is the fallback. Both cost more than filing on time.

Can I roll equity into the buyer without paying tax on that piece?

Yes, and it is the strongest seller-side reason to accept the structure. When the buyer purchases part of the LLC interests and you keep the rest, Rev. Rul. 99-5 treats it as a purchase of an undivided share of the assets followed by a contribution to a new partnership under §721, so the retained portion is not taxed. A §338(h)(10) election gives you the opposite answer and taxes the rollover in the year of the sale.

The Journal / Business Tax

F Reorganization Before Selling an S Corp: What It Costs You.

By Ewan Morkel, EAAugust 15, 20266 min read

An F reorganization is tax-free when it happens, and then it turns your stock sale into an asset sale. On a $12,000,000 exit with $1,400,000 of fully expensed equipment, that character change costs the seller $238,000.

Small business owner using a laptop at his desk

A fabrication shop in Utah County, one shareholder, an S corporation since 2011. The letter of intent says $12,000,000, and on page four there is a sentence saying the company will complete a pre-closing reorganization. The buyer's counsel calls it standard, and it is. An F reorganization before selling an S corp is the default structure in middle-market deals now. It is also not free to you, and on this deal it costs $238,000.

The structure

Four steps, and none of them is taxable.

Section 368(a)(1)(F) covers "a mere change in identity, form, or place of organization of one corporation, however effected." Rev. Rul. 2008-18 confirmed that dropping an S corporation underneath a new holding company fits that description, and the sequence has been standard ever since.

01The shareholders form a new corporation, call it Holdco. It files no Form 2553. Under Rev. Rul. 64-250 the old corporation's S election continues for the new one, and that continuity is the entire reason to use an F reorganization instead of a fresh incorporation.
02Every shareholder contributes every share of the operating company to Holdco in exchange for Holdco stock, in the proportions they already held.
03Holdco files Form 8869 electing to treat the operating company as a qualified subchapter S subsidiary, effective immediately after the contribution. Line 14 gets checked yes, which tells the IRS the election is part of a §368(a)(1)(F) reorganization under Rev. Rul. 2008-18.
04The QSub converts to a single-member LLC under state law. A QSub is already disregarded under §1361(b)(3)(A), so the conversion is a nonevent federally.

The housekeeping is settled in the same ruling. The operating company keeps its EIN, Holdco gets a new one, and the old S corporation files no final return. Its tax year, accounting methods, depreciation schedules, and payroll history all continue in place. The operating entity never legally moved either, so licenses and contracts survive better here than in a straight asset sale. Better isn't untouched: a corporation-to-LLC conversion can still trip an assignment clause, and that one is for your counsel with the contracts in hand.

Why the buyer asks

Your buyer is shopping for basis.

In a plain stock sale the buyer inherits your basis. Here the buyer buys the LLC interests of a disregarded entity, which is a purchase of the underlying assets, so everything comes in at its allocated share of the price. Goodwill amortizes straight line over 15 years under §197(a). Used equipment qualifies for 100% bonus depreciation, permanent for property acquired after January 19, 2025 under §70301 of the One Big Beautiful Bill Act. That is worth real money, and I price it below.

The older route to the same place was a §338(h)(10) election, and it carries conditions this structure does not. The buyer has to be a corporation making a qualified stock purchase of at least 80% of the target's vote and value inside a 12-month period, on a joint Form 8023 due by the 15th day of the ninth month after the month of the acquisition. Most private equity buyers acquire through an LLC and fail at the first hurdle.

Two more differences finish the argument. A §338(h)(10) election taxes any equity you roll into the buyer, while in the F structure the rolled interest goes into a new partnership under §721 untaxed, on the Situation 1 analysis in Rev. Rul. 99-5. And that election is void if the S election was never valid, staking the buyer's whole step-up on twenty years of shareholder consents and trust eligibility being clean. The F structure doesn't. Your buyer still diligences your S election, because a failed one makes Holdco a C corporation and adds a corporate-level tax to the sale, but that becomes an indemnity rather than a lost step-up. It is also why a late S corporation election is worth cleaning up long before an exit.

The seller's side

What an F reorganization before selling an S corp costs you.

Everything above is the buyer's case. Yours is a character problem. A stock sale produces one number taxed one way, long-term capital gain. An asset sale splits the price across seven classes under the residual method of §1060, reported by both sides on Form 8594, and each class carries its own rate. Goodwill is §1231 gain and lands at capital rates. Equipment does not. Every dollar of depreciation you ever claimed on it comes back as ordinary income under §1245, and after a decade of bonus depreciation that basis is usually zero.

One $12,000,000 exit, taxed two ways, 2026.

Purchase price for the business: $12,000,000
Receivables and inventory, basis equal to value: $1,500,000
Equipment fully expensed under bonus depreciation, basis $0: $1,400,000
Goodwill and going concern value, basis $0: $9,100,000
Total gain, either structure: $10,500,000
Stock sale: all long-term capital gain at 20%: $2,100,000
F reorganization: $1,400,000 of §1245 recapture at 37%: $518,000
F reorganization: $9,100,000 of §1231 gain at 20%: $1,820,000
Federal tax after the F reorganization: $2,338,000
What the structure costs the seller: $238,000
Purchase price bump that makes the seller whole: $297,500

Tax year 2026, sole shareholder filing jointly, federal only. Assumes a debt-free cash-free deal with no earnout and no installment note, stock basis equal to the corporation's $1,500,000 inside basis, all assets held more than a year with no §1231 lookback losses, and corporate goodwill rather than personal goodwill. Taxable income sits above the $613,700 where the 20% capital gains rate starts for a joint return in 2026 and above the $768,700 where the 37% bracket starts, both under Rev. Proc. 2025-32. The 3.8% net investment income tax under §1411 is left out of both columns because the total gain is $10,500,000 either way, so it does not move the $238,000 difference; whether it applies at all turns on material participation. State tax is excluded.

That $238,000 is the whole argument, and it is worth having. Ask for a purchase price increase, and remember the increase gets taxed too: at 20% it takes $297,500 of extra goodwill proceeds to leave you holding $238,000. Then look at what you are asking your buyer to give up. The $9,100,000 of goodwill throws off $606,667 of §197 amortization a year, worth $127,400 a year to a corporate buyer at the 21% rate and $1,911,000 across the 15 years. The $1,400,000 of equipment is a first-year deduction worth another $294,000. A buyer trading $2,205,000 of deductions for a $297,500 bump is getting a bargain, and most of them know it. Sellers hand this over because nobody told them there was anything to negotiate.

Where it breaks

Two failure points, both of them on the calendar.

The first is the QSub election. Rev. Rul. 2008-18 works only if the election is effective immediately after the stock contribution, and Form 8869 generally has to be filed no later than 2 months and 15 days after that effective date. File it late and the election is pushed forward to 2 months and 15 days before the filing date, which is not what happened. Miss it and there was no F reorganization at all: Holdco's S election never attached, and a transaction everyone treated as tax-free is not. Reasonable cause relief exists and a private letter ruling exists, and both are worse than a calendar reminder.

The second is doing it at the closing table. The 2015 final regulations at Treas. Reg. §1.368-2 set six requirements for a mere change, and two of them matter in a deal: the same people have to own the resulting corporation in identical proportions, and Holdco cannot hold property or tax attributes before the transfer. Both are tested on the reorganization, not on the sale that follows. The exposure is that a reorganization signed the morning of a closing invites the argument that the two steps were really one, and no published guidance blesses a same-day version. Sixty days of separation costs nothing and removes it. If the buyer is your own employees instead, none of this applies and selling your company to an ESOP runs on a different section entirely.