S Corp questions - probably over my head

[BulldogTom]

S Corp is looking at succession planning.   3 shareholders right now, Grandma (40%), Grandpa (40%) and Mother (10%).   Grandma is the President.   GM & GP want to pass their ownership to Grandchild #1 and Grandchild #2 eventually but keep M in control of the company.   S-Corp owns highly appreciated real estate that generates rental income.   There is only a small amount of debt on the property.

Taxpayer plan is to convert to a Limited Partnership.   GM & GP would form trusts holding their partnership interests.   The trusts would then pass the partnership interests to GC#1 and GC#1.

I don't think there is a way to get a non-taxable re-organization of the company from SCorp to LP?

If I understand the general rules correctly, the SCorp needs to essentially buy all the outstanding stock from the shareholders in a liquidating transaction.   The SCorp will calculate gain or loss and that will increase the stock basis of the shareholders, and then the shareholders will calculate gain or loss on the sale of their shares to the corp.   Do I have the basics correct?

However, since the parties are all related, they don't get Cap Gain treatment on the sale (§1239).   Am I interpreting this correct?

Assuming FMV of 3MM and Adjusted Basis of 700K, the Corp would distribute income of 2.3MM to the shareholders via their K1 and the shareholders would pay tax at ordinary rates on that amount.   The 2.3MM is the sales price for their shares, assuming basis of of 200K plus the 2.3MM distributed, would produce a loss on the redemption of their shares of 200K which would be capital in nature.

Finally, the shareholders would contribute their stepped up basis property to the new LP and continue in business.

Am I anywhere near on the right track?

Tom
Longview, TX

 

[Lee B]

I think I remember a discussion thread early last year or spring where there is a tax free reorganization that is available?

[Lee B]

Here's the link to the article in The Tax Advisor:

https://www.thetaxadviser.com/issues/2020/sep/private-equity-f-reorganizations-s-corporations.html

Hope it's helpful

[BulldogTom]

1 hour ago, Lee B said:

Here's the link to the article in The Tax Advisor:

https://www.thetaxadviser.com/issues/2020/sep/private-equity-f-reorganizations-s-corporations.html

Hope it's helpful

Thanks Lee.   I saw that in my research.   Very helpful.   Lets me know I am not able to advise the client on the F type reorganization option.   

I think I am on the right track with how the taxation goes if they liquidate the corp and then fire up a new LP.   Just looking for some re-assurance that I am applying the related party rules correctly.

Tom
Longview, TX 

[DANRVAN]

13 hours ago, BulldogTom said:

I don't think there is a way to get a non-taxable re-organization of the company from SCorp to LP?

I am familiar, but not experienced with a process called an inversion.  I believe it works somewhat as follows and is considered an F type reorg:

Basically a new corp Y is formed by shareholders of existing corp X.  Shareholders transfer their shares to Y in exchange for their shares in X.

X then makes an election to be a qualified sub chapter S subsidiary, and therefore X becomes disregarded for tax purposes.  

Y forms Z, a wholly-owned LLC. which is initially disregarded for tax purposes.  Then X is  merged into Z, with Z as the survivor of the merger.

The key here is that both X and Z are disregarded when the conversion takes place.

I would not attempt this without experienced legal guidance.

13 hours ago, BulldogTom said:

   GM & GP would form trusts holding their partnership interests.   The trusts would then pass the partnership interests to GC#1 and GC#1.

Why can't they meet their objective by transferring existing stock to the trust and M?

[DANRVAN]

46 minutes ago, DANRVAN said:

transferring existing stock to the trust

Yeah, most trust cannot be S corp shareholders, past my bedtime.

But how long will the trust hold the stock?  Before death or after death of GP and GM?  Maybe another way to meet their objective?

 

[BulldogTom]

7 hours ago, DANRVAN said:

Why can't they meet their objective by transferring existing stock to the trust and M?

Non tax reason.   They are teenagers and the Grandparents want the mother to have control until they grow up.  In an SCorp, you own the shares you own the votes.   In a partnership, you can split control from profits.   At least that is what they expressed to me.

Tom
Longview, TX

[BulldogTom]

7 hours ago, DANRVAN said:

I am familiar, but not experienced with a process called an inversion.  I believe it works somewhat as follows and is considered an F type reorg:

Basically a new corp Y is formed by shareholders of existing corp X.  Shareholders transfer their shares to Y in exchange for their shares in X.

X then makes an election to be a qualified sub chapter S subsidiary, and therefore X becomes disregarded for tax purposes.  

Y forms Z, a wholly-owned LLC. which is initially disregarded for tax purposes.  Then X is  merged into Z, with Z as the survivor of the merger.

The key here is that both X and Z are disregarded when the conversion takes place.

I would not attempt this without experienced legal guidance.

That is what I told them.   I cannot guide or advise them in this transaction as I don't have the skill or experience to do so.   

Tom
Longview, TX

[Lee B]

Just curious, did GP & GM ever consider a plan that would utilize their step up in basis when they passed?

[BulldogTom]

I asked that question and I am waiting for a response from the client.

Tom
Longview, TX

[jklcpa]

This is beyond me, and I'm not thinking clearly ATM anyway. Even if I could though, this needs to be incorporated in their overall estate plans, so I'd be sending them to an attorney that specializes in tax and estate planning.

[BulldogTom]

2 minutes ago, jklcpa said:

This is beyond me, and I'm not thinking clearly ATM anyway. Even if I could though, this needs to be incorporated in their overall estate plans, so I'd be sending them to an attorney that specializes in tax and estate planning.

Attorney was on the email they sent me.

Tom
Longview, TX

[Lion EA]

Maybe why this scheme appears to be overly complicated !!