S-Corp selling to Partnership. S-Corp rollover equity.

I have a client that owns an S-Corporation. They are selling 80% of their stock to a partnership and are going to rollover 20% of their stock into equity interest in the partnership. I assume that 20% rollover is going to be taxable. Correct?

I suspect the only way they can avoid tax on the 20% is through an F reorganization as described here:
https://www.thetaxadviser.com/issues/20 ... tions.html

The problem with the reorg is that CA charges a 1.5% S-Corp net income tax. This reorganization will convert the stock transaction into an asset transaction. Now they have to pay this tax. And it is going to be substantial.

Of course, the buyer is happy, because now they get asset basis.

Read the purchase agreement and see what you got. Sounds like the F reorg.

20% gets rolled into new partnership tax free under 721, with buyer and seller as 80/20 partners. You probably will have 704(c) difference upon contributions into the new partnership.

S corp reports the sale of 80% of its assets on return. S corp should also get k-1 from new partnership for that year as well depending on the date of sale.

Agreed.

I've had two of these transactions in the last year. Is the buyer assisting in structuring the transaction?
In my transactions, there was an F reorg that creates a new parent, a Qsub for the original S-corp, conversion of the original S to an LLC, and the LLC is sold/contributed to the purchaser.

Thank you, both.

The letter of intent is a stock transaction. 80% purchase, 20% rollover.

The F reorg works to avoid tax on the 20% rollover. However, CA has their stupid 1.5% S-Corp net income tax which becomes an additional transaction expense. We would not have this on a stock deal.

Trying to get the buyer to pay for this, because now they get the benefit of the asset basis. But, for some reason, they seem to be an indifferent about this.

They probably say they factored that into the purchase price they offered.

Of course, it would be best to keep things amicable. But I wonder what would happen if we called their bluff and said, "OK, we will do the stock deal and just go ahead and pay tax on the 20% now."

The tax on the 20% is just a deferral, anyhow. While the 1.5% CA tax is an actual additional transaction tax.

1.5% x 80% = 1.2% additional tax

While 30% (20% Fed + 10% CA) x 20% = 6.0% deferred tax

Do F reorg. Stock sale would make this messy. Good for buyer and seller, just need to agree on price.