Page 508 - TaxAdviser_2022

TAX CLINIC

properly determined without first deter-
mining Sec. 704(b) income. Second, it is
important to first determine a prelimi-
nary capital account for each member
and the LLC before the final targets can
be determined. Attempting to shortcut
any of these steps will lead to problems
for any allocations that have any level
of complexity.
Finally, it is worth discussing Step 7.
This is the step in which the allocations
to each member will first be determined.
The agreement will need to be carefully
analyzed to determine whether alloca-
tions will be made of bottom-line net
income/loss, or whether the agreement
provides for the use of gross revenue or
expense items for the purpose of bring-
ing the capital accounts fully into sync
with the hypothetical year-end distribu-
tion. A good deal of uncertainty sur-
rounds this particular topic that is well
beyond the scope of this discussion. It
is within this Step 7 that a practitioner
would need to make judgments regard-
ing the manner in which these rules will
be applied.
Following these 11 steps in the order
presented — and avoiding shortcuts
in the process — is a sound strat- want to maintain flowthrough status intends to sell her entire interest. The
egy for managing this aspect of your but are not eligible to be S corporation transaction structure with the buyer is
tax practice. shareholders, while others may want to simple: all cash, with no earnouts or sell-
From Joseph Schlueter, CPA, J.D., own a C corporation as a result. How- er notes. Additionally, the S corporation
Minneapolis ever, one issue that continually arises is does not have any unrecognized built-in
the desire for certain shareholders to roll gain or residual earnings and profits
a portion of their equity into the buyer, from any time previously structured as a
S Corporations while other shareholders do not roll any C corporation.
equity. This item discusses some ways to When the desire is for the target to
Rolling over shares upon effectuate this and the corresponding tax maintain flowthrough status, one of the
S corporation’s acquisition implications. This item does not address typical structures in the M&A space is
S corporations are widely used through- the family attribution rules. performing an F reorganization under
out the country, primarily by privately The first thing to note is that there Sec. 368(a)(1)(F). In this structure, a
held businesses. As there has been an are no perfect solutions for this situa- new S corporation holding company is
increase in merger-and-acquisition tion, and the rolling shareholder will be formed by the owners of the target S IMAGE BY PHOTOALTO/SANDRO DI CARLO DARSA/GETTY IMAGES
(M&A) activity in recent years, there adversely affected primarily through the corporation, and the owners’ target stock
has also been a disproportionately large timing of gain recognition and cash. For is transferred to this new S corporation.
number of S corporations selling as they the examples below, it is assumed that The target S corporation is converted
become part of larger investment groups. there is one S corporation that is owned to a disregarded entity or an LLC taxed
A few typical structures are used when equally by two shareholders. Shareholder as a partnership. Then, the new S cor-
buying S corporations, depending on A intends to roll over his entire inter- poration sells a portion of the target
the desired result. Certain buyers may est into the buyer, while Shareholder B (which is now a disregarded entity or

22 October 2022 The Tax Adviser