Friends, let me set the scene.

You’ve built something extraordinary. A $20M, $40M, maybe $75M business or more. Private equity is calling. The LOI is on the table. Champagne is chilling in the fridge. And then, right on cue, your M&A attorney sends over a term sheet with words that make most business owners’ eyes glaze over:

“The buyer is requesting a 338(h)(10) election… alternatively, we could structure this as an F Reorganization…”

Holy cannoli. Is it too much to ask for a plain-English explanation of what the heck these things mean, who benefits, and when you use each one?

Of course it is. That’s why you’ve got me.

So let’s break this down like the seasoned tax geeks we are, and I promise you’ll walk away knowing exactly which structure works for you .

The Core Problem: Buyers and Sellers Want Opposite Things

Here’s the fundamental tension in every business sale: buyers love asset sales; sellers love stock sales.

Why? It all comes back to basis and tax character.

• Sellers prefer a stock sale because it delivers clean capital gains treatment. You sell your stock, pay long-term capital gains rates, and go enjoy that beach house in the Caribbean.
• Buyers prefer an asset sale because they get to step up the tax basis of everything they acquire to fair market value, meaning years of fresh depreciation and amortization deductions to shield future income from tax.

Now here’s where it gets interesting. Two provisions of the Internal Revenue Code act as bridge builders between these competing interests, allowing a transaction to be a stock sale for legal purposes but an asset sale for tax purposes . Those provisions are Section 338(h)(10) and Section 368(a)(1)(F).

Both give the buyer the coveted step-up in basis. Both let the seller legally sell stock rather than assets. But the mechanics, eligibility rules, risks, and flexibility are very, very different. Think of them as two Italian cousins — same family, very different personalities.

FIGHTER #1: The 338(h)(10) Election — The Shapeshifter

What Is It?

A Section 338(h)(10) election is a joint election made by both the buyer and all selling shareholders that recharacterizes what is legally a stock purchase as a deemed asset purchase for federal income tax purposes.

Here’s what the tax fiction looks like under the hood:

1. The buyer is deemed to create a “New Target” corporation
2. New Target is deemed to buy all assets of the “Old Target” at fair market value
3. Old Target is deemed to liquidate in the hands of the sellers
4. The stock sale itself is ignored for tax purposes
5. Result : Generally only one level of tax on the deemed asset sale rather than double taxation

The buyer ends up with a stepped-up basis in all the target’s assets, equal to the purchase price, which gets allocated among the assets per the Section 338 rules (similar to a 1060 asset allocation). This means the buyer can now depreciate and amortize the full purchase price, including goodwill, creating tax shields that can be worth millions over the life of the investment.

The Eligibility Rules (aka The Fine Print That Ruins Deals)

Here’s the deal, and I say this with 40 years of professional scar tissue, the 338(h)(10) has a very narrow lane :

• Target must be an S Corporation (or a subsidiary in a consolidated C corp group but for our mid-market world, we’re mostly talking S corps)
• Buyer must be a corporation — S corp or C corp. This means most PE buyers using LLC acquisition vehicles are disqualified right out of the gate
• Buyer must acquire at least 80% of the total combined voting power and value of the target’s stock
• Joint election required — every single selling shareholder must consent. One holdout and the whole thing unravels
• The entire structure depends on the S corp election being and remaining valid at the time of closing

That last one? That’s the kryptonite.

The 338(h)(10) Risks — Where Things Can Go Sideways

Let me be blunt. The 338(h)(10) has real risks that your garden-variety M&A attorney may not adequately flag:

1. S Corp Election Validity Risk
   This is the big one. If the target’s S corporation election was ever inadvertently terminated, say, an ineligible shareholder received stock, or a second class of stock was accidentally created through a loan with equity-like features, the 338(h)(10) election is VOID . The buyer wakes up post-closing without a step-up in basis. That’s not a typo. They bought what they thought was a fresh asset basis, and they got… nothing. This is a nightmare scenario that I can tell you I’ve seen create serious post-closing litigation.
2. Rollover Equity Is Effectively Impossible on a Tax-Deferred Basis
   PE buyers frequently want sellers to “roll” 10-30% of their equity back into the deal — maintaining skin in the game for a second bite of the apple. Under a 338(h)(10), rollover equity is capped at 20% of pre-transaction equity and is generally taxed immediately, no deferral. That’s a deal-killer for many sellers.
3. Buyer Must Be a Corporation
   Most PE funds use LLCs or partnerships as their acquisition vehicles. That automatically disqualifies the 338(h)(10) for the vast majority of private equity transactions.
4. Seller Tax Consequences Can Be Ugly
   The deemed asset sale triggers gain recognition, which may include ordinary income on depreciation recapture (Sections 1245 and 1250), recognition of built-in gains if the target was previously a C corp, and potentially higher tax on certain asset categories. The seller is giving up the clean stock sale tax treatment, so buyers often need to gross-up the seller’s proceeds to compensate thus reducing the buyer’s economic return.
5. Purchase Price Allocation Battles
   The step-up allocation under Section 338 follows the residual method (IRC §1060 rules), and buyers and sellers can end up in fierce negotiations over how gain is allocated among asset classes, since ordinary income assets and capital gain assets receive very different tax treatment.

FIGHTER #2: The F Reorganization — The Teleporter

What Is It?

The F Reorganization, defined under Section 368(a)(1)(F), is described in the Code as simply a “mere change in identity, form, or place of organization of one corporation, however effected.” That sounds deceptively simple. What it actually does in an M&A context is elegant financial engineering.

The F Reorg is typically a pre-closing restructuring done before the deal closes, that repositions the S corporation in a way that lets the buyer purchase LLC interests (treated as an asset purchase for tax purposes) rather than S corp stock, achieving the same step-up result as a 338(h)(10) without the eligibility restrictions.

The Mechanics: How the F Reorg Works Step-by-Step

Think of this as a three-act Italian opera — dramatic, precise, and beautiful when executed correctly:

Step 1: Shareholders of the existing S corporation (“OldCo”) form a new corporation (“NewCo” or “HoldCo”). NewCo is a fresh entity with no assets and no tax history.

Step 2: OldCo shareholders contribute their OldCo stock to NewCo in exchange for NewCo equity in the same proportions as before . NewCo then makes a Qualified Subchapter S Subsidiary (QSub) election on IRS Form 8869, making OldCo a disregarded entity (QSub) under NewCo. This is a tax-free event for both the corporation and its shareholders.

Step 3 (for pass-through buyers): OldCo (now a QSub) is converted from a corporation to a single-member LLC under state law, no sooner than one day after the QSub election is filed. The Target LLC remains a disregarded entity for federal income tax purposes. This conversion is also a nontaxable event.

Post-reorg: The buyer purchases membership interests in Target LLC. Because Target LLC is a disregarded entity, this is treated as an asset purchase for tax purposes even though legally it’s an equity purchase. BOOM. Step-up in basis achieved, without the 80% rule, without the corporate buyer requirement, and with full flexibility for rollover equity.

The F Reorg Advantages — Why It’s Winning the War

1. No 80% Minimum Purchase Requirement
   Unlike the 338(h)(10), the F Reorg has no threshold for how much the buyer must acquire. A buyer acquiring 60%, 70%, or 51% can still achieve the step-up. The basis step-up is limited to the portion acquired directly.
2. Tax-Deferred Rollover Equity — This Is HUGE
   Sellers rolling equity can defer recognition of gain on the rolled portion. Under the F Reorg structure, NewCo contributes the Target LLC interests into the buyer’s acquisition vehicle while retaining the rollover equity, and this can be structured as a tax-deferred contribution as long as the buyer vehicle is a partnership for tax purposes. Sellers get to defer tax on their rollover AND participate in the upside of the next exit. Chef’s kiss.
3. Buyer Entity Type Flexibility
   PE funds, LLCs, and partnerships can all use the F Reorg structure. This is the dominant reason why F Reorgs have become the preferred structure for the vast majority of private equity-backed middle market transactions.
4. S Corp Election Risk Is Neutralized
   This is a game-changer for buyers. Because the Target LLC is a disregarded entity after the F Reorg, the step-up in basis is achieved through the asset acquisition mechanics, not through the S corp election’s validity. Even if OldCo’s S election had a historical defect, the buyer’s basis step-up is protected . (Note: historic C corp income tax liabilities could still be inherited under state successor liability law, so due diligence on this point remains essential.)
5. Business Continuity
   Licenses, contracts, EIN, payroll systems, vendor relationships. All of these generally stay intact because the assets never actually moved. The IRS treats this as a “mere change in form,” which means far fewer change-of-control consent headaches than a true asset sale.
6. Preserves Historic Tax Attributes at NewCo
   NewCo (HoldCo) retains the S corporation’s original tax attributes, including the EIN of OldCo at the QSub level, simplifying administrative transitions considerably.

The F Reorg Risks — Because Nothing Is Perfect

1. Pre-Closing Complexity and Timing
   The F Reorg requires careful sequential execution before closing. Mess up the order of steps, especially the one-day gap between the QSub election and the LLC conversion, and you could blow the reorganization’s tax-free treatment. This is not a DIY project. You need experienced M&A tax counsel.
2. State Tax Conformity Issues
   Not all states play nicely with federal F Reorg rules. Some require separate state S corp and QSub elections . Others don’t recognize the disregarded entity treatment of QSubs. If you’re selling a business with multi-state nexus, this requires careful state-by-state analysis. Get your state tax advisors in the loop early.
3. Shareholder Notification Requirements
   After the F Reorg, the seller must notify the IRS and applicable state/local jurisdictions of the name change (from Inc. to LLC), and may need to transfer estimated tax payments from the old account to the new S corp account. Not a showstopper, but an administrative burden that needs to be managed.
4. Anti-Churning Rules
   Transactions involving rollover equity must address the anti-churning rules under Section 197, which can limit amortization on intangibles if the transaction is deemed a related party arrangement. Proper structuring can navigate this, but it needs attention upfront.
5. Disproportionate Rollover Complications
   If multiple sellers are rolling different percentages of their equity, the deal structure gets significantly more complex. Careful modeling of each seller’s individual tax outcome is essential.

The Decision Matrix: When to Use Each Structure

Consideration

338(h)(10)

F Reorganization

Target entity type

S corp only

S corp (most common)

Buyer entity type

Must be a corporation (S or C)

Any — LLC, partnership, PE fund

Minimum acquisition %

80% required

No minimum

Tax-deferred rollover equity

Generally NOT available

Available

S corp election risk

High — validity required

Low — basis protected

Business continuity

Good

Excellent

Complexity / cost

Moderate

Higher (pre-closing restructuring)

State conformity

Generally consistent

Varies — need state analysis

EIN retention

No — new target EIN

Yes

Best for

Strategic corporate buyers, 100% acquisitions, simple ownership structures

PE buyers, partial acquisitions, rollover equity deals, risk-averse buyers

When Would You Actually Use a 338(h)(10)?

Let’s be honest, the 338(h)(10)’s narrow lane means it still has its place , even in 2026:

• Strategic corporate buyer (not PE) acquiring 100% of a clean, validly elected S corporation
• Simple, single-shareholder situations where rollover isn’t needed and the S election history is airtight
• C corp consolidated group acquisitions , where a parent corp is selling a C corp subsidiary (a different but related application of §338(h)(10))
• When all selling shareholders agree and the economics work for both parties (buyer’s basis step-up benefit exceeds seller’s incremental tax cost)

The key: model it carefully. The seller is giving up clean capital gains treatment in exchange for (hopefully) a higher purchase price gross-up from the buyer. If the math doesn’t work for both sides, the election shouldn’t be made.

When Would You Use an F Reorganization?

This is the structure I’m recommending in the vast majority of middle market S corp M&A transactions today , and here’s why:

• PE buyer using an LLC/partnership acquisition entity — which is almost every PE deal
• Seller wants to roll equity on a tax-deferred basis — increasingly common as sellers seek “second bite of the apple” strategies
• Uncertain or complex S corp election history — the F Reorg neutralizes that landmine
• Partial acquisitions below the 80% threshold
• Sellers who want maximum flexibility in post-closing capital structure (preferred equity, different classes, carried interest, etc.)
• Multi-seller deals where one or more sellers have different rollover goals

The Real-World Numbers: Why This Matters

Here’s a concrete example to bring this home. Suppose you’re selling your $30M S corp. The buyer wants a step-up in basis. Let’s assume the asset allocation creates $5M of ordinary income and $25M of capital gain on a deemed asset sale.

Under a straight 338(h)(10) , the seller might pay tax of approximately $1.2M in ordinary income taxes plus $5M in capital gains taxes, for a total of roughly $6.2M in federal taxes.

If you roll 20% of your equity ($6M of proceeds) in an F Reorg structure , that $6M of gain defers, saving you approximately $1.2M in current taxes on the rollover portion alone. That’s money working for you in the next deal rather than going to Uncle Sam today.

And friends, that’s just the federal number. Don’t forget your state.

Bottom Line: The F Reorg Is Winning — Here’s Why

Over the decades, I’ve watched structures come and go, elections misfire, and deals implode because someone chose the wrong tool. The consistent trend I’ve observed over this time: flexibility wins.

The F Reorganization has become the dominant pre-closing structure for middle market M&A transactions involving S corporations precisely because it solves the biggest pain points of the 338(h)(10) — buyer entity restrictions, rollover equity limitations, and S election validity risk — while delivering the same core benefit: a full step-up in tax basis for the buyer.

That said, this isn’t a religion. There are situations where the 338(h)(10) is the right tool. The best advisors, the strategic ones, not just the compliance factories, model both scenarios, stress-test the S corp election history, analyze the rollover equity goals, and select the structure that maximizes after-tax value for all parties.

That’s not just tax preparation. That’s wealth preservation. And in my tax mitigation heart, that’s the whole ballgame.

Your Pre-Sale Action Items

If you’re contemplating a sale in the next 1-3 years, here’s what needs to happen now, not the week before closing:

1. Audit your S corp election history. Get your tax advisor to review every year of your S corp status for potential defects (ineligible shareholders, second class of stock issues, improper transfers, etc.). Fix problems before buyers find them.
2. Define your rollover equity goals. How much do you want to roll? At what terms? This decision drives the structure choice.
3. Understand your asset mix. The ratio of ordinary income assets (receivables, inventory, recapture) to capital gain assets (goodwill, real property) dramatically affects the seller’s net economics in any deemed asset sale.
4. Build your advisory team early. You need M&A tax advisors, M&A tax and legal counsel, and a financial advisor who all communicate with each other. Silo’d advisors create structural landmines. Spend money on your deal team. It will save you significantly down the road.
5. Model both structures. Don’t let a buyer dictate the structure without running the numbers yourself. Every deal is different.
6. Address state tax implications. Especially if you have multi-state operations. F Reorg conformity varies by state, and surprises at closing are expensive.

Want to dig deeper on M&A tax structuring, exit planning, or pre-transaction entity optimization? Reach out to us at [email protected] — we’d love to put our tax-geek brains to work on your specific situation.

And as always, the information above is educational in nature and not tax or legal advice for your specific transaction. Every deal is different, and the devil, as always, is in the details.

Grazie Mille, Ciao!