Home
About Us
Practice Areas
Businesses and their owners sometimes find it necessary or advantageous to move assets around, whether between companies, to shareholders or partners. Such transfers often have adverse tax consequences for the owner, such as taxes on capital gains, depreciation recapture, or forfeiture of tax losses.
While each transaction is different, the IRS Code allows tax-free transfers of assets to occur under certain circumstances. Such tax-fee transfer of assets can be accomplished by changing the structure of the owner’s business. The typical term is a type of “spin-off” frequently referred to as a “Type D Reorganization” or a “Type F Reorganization.”
These transfer techniques are approved by the IRS and are useful to business owners in a number of different ways. Most commonly, they are used to separate the liabilities of a business from its assets. For example a medical practice that is structured as a corporation often owns diagnostic equipment, an office building, and serves as the entity through which its doctors practice medicine. While this may be a convenient approach, it is dangerous, since a malpractice judgment against the practice might result in the seizure and sale of the building, the medical equipment, and other assets to pay the judgment.
To limit this exposure, business owners can divide the business in a tax-free reorganization that moves the building into a newly-formed corporation, the equipment into a second newly-formed corporation, and the medical practice into a third newly-formed corporation. Once separated into separate corporations, a court judgment against the medical practice corporation should not jeopardize the building or the equipment owned by separate corporations.
A Type F Reorganization can also be used in the context of merging different types of entities, such as combining an S corporation into an LLC (limited liability company). An LLC is usually an easier entity to operate than an S corporation and an LLC has more flexibility when it comes to raising capital. Before the advent of the Type F Reorganization the transfer of assets from an S corporation or C corporation would trigger income taxes as if the assets were sold. With a C corporation, the IRS would impose the tax on the corporation, and with an S corporation, the IRS would impose the tax on the shareholders.
Under some circumstances, there could be a double tax on both the corporation and the shareholders. Older techniques such as a Type D Reorganization could be used but this was not as taxpayer-friendly as the newer Type F approach. The bottom line is that there is no tax on the transfer of assets to the LLC, and the LLC can often continue using the same tax ID number as the old S corporation, thus simplifying tax record-keeping.
Finally, a tax-free reorganization of a business can be a useful estate planning tool. By breaking the family business into smaller companies, the parent company can target which parts of the business go to which children or grandchildren. Perhaps the real estate owned by a manufacturing company is segregated into an LLC that will be gifted to grandchildren while the operating division of the company is kept in a different LLC that will go to the children who are involved in running the business. Thus, reorganizations of a family business are especially important in succession planning where the issues of future control and tax cost of transfers are critical.
The details of a tax-free reorganization involve the attorney creating new corporate entities and working with the CPA to file the proper tax forms. Both steps are and the associated costs are one time events, but can create large tax savings.