Same Business, New Number: Rev. Rul. 2008-18, the 60-Month Rule, and the Price of the Fix

By Douglas S. Stransky, J.D., LL.M.  | Partner, Sullivan & Worcester LLP

There is a structuring sequence so common in S corporation M&A that deal lawyers can draft it from memory. It works beautifully until the target’s own history breaks it, and it usually breaks in the middle of a live deal.

As with the earlier posts in this series, the facts are invented. Kestrel Machine LLC is a precision parts manufacturer, formed years ago as a limited liability company and taxed for its first stretch of life as a partnership. In early 2023, the founders, on their accountant’s advice, elected S corporation status for payroll planning.

In mid-2026, a U.K. strategic arrives with an attractive offer, acquiring through its U.S. subsidiary. A straight stock purchase is possible, but it would terminate Kestrel’s S election and, absent a Section 338 election, leave the buyer with basis in the stock rather than a stepped-up basis in Kestrel’s assets. A Section 338(h)(10) election could produce deemed asset treatment, but the founders also want to roll a portion of their equity tax-free. The parties therefore turn to the familiar pre-closing F reorganization, which allows the operating business to be sold as a disregarded entity.

The buyer wants asset treatment for the same reason any buyer does: Kestrel’s profits will remain subject to U.S. tax after closing, and a stepped-up basis in the assets, with goodwill amortizable over 15 years under Section 197, shelters those profits well into the future.

The regular F and why Rev. Rul. 2008-18 made it routine

The sequence runs in three steps. The founders form a new holding corporation and put Kestrel underneath it. The holding company elects to treat Kestrel as a qualified subchapter S subsidiary under Section 1361(b)(3). Then, before closing, Kestrel becomes a disregarded entity, so that the buyer’s purchase of its interests is an asset purchase for U.S. tax purposes while remaining an equity deal on paper.

Rev. Rul. 2008-18 is what makes the first two steps boring, and boring is the highest compliment in deal tax. The ruling describes two routes to the same place.

In Situation 1, the shareholder of an S corporation contributes all the stock to a newly formed holding corporation, which elects to treat the target as a QSub effective immediately after the transfer.

In Situation 2, the S corporation itself forms the holding corporation, the holding corporation forms a merger subsidiary, and the merger subsidiary merges into the target, with the shareholder receiving holding company stock in the exchange; the same immediate QSub election follows.

The contribution route is simpler to document, but the merger route earns its keep when the target has more than a few shareholders, because a state-law merger binds everyone through a vote instead of requiring each holder to sign a contribution agreement. Either way, the ruling confirms the transaction is a reorganization under Section 368(a)(1)(F), a mere change in identity or form.

The holdings that follow are the ones deal teams rely on. The S election survives and does not need to be remade; it carries up to the new parent without a new Form 2553. And the employer identification numbers sort themselves sensibly: the new holding company obtains a new EIN, while the operating company keeps the EIN it has always had. The ruling even tests that result, because in Situation 1 the holding company later sells a 1% interest in the target, ending its QSub status, and the target continues with its original EIN all the same.

In practice, keeping the EIN is the part clients notice. The operating company is the entity with the payroll accounts, the state registrations, the licenses and permits, the customer vendor files and the bank relationships, all of them keyed to its EIN. Under the regular sequence, none of that moves. The business that signs the purchase agreement is, for every administrative purpose, the same business it was the day before the reorganization began.

Where the 60-month rule breaks the sequence

Step three is where the two kinds of target part company. For a target that started as a state-law corporation in a state with a conversion statute, Delaware being the everyday example, becoming a disregarded entity is a formless conversion into an LLC: the same legal entity continues, the resulting single-member LLC is disregarded by default, and no federal election is filed, so no election rule can object.

Kestrel is different. It is already an LLC, and it holds corporate status only because of its S election. Under Treas. Reg. Section 301.7701-3(c)(1)(v)(C), an eligible entity that timely elects S corporation status is deemed to have elected classification as an association, so no Form 8832 was required and none was filed. Some practitioners file a protective Form 8832 alongside the Form 2553 anyway, which changes nothing substantive but leaves a cleaner paper trail for a diligence team to find.

Filed or deemed, the election carries the same consequences, including the one that matters here. Under Treas. Reg. Section 301.7701-3(c)(1)(iv), an entity that elects to change its classification generally cannot elect to change it again within 60 months of the effective date of the earlier election, and the deemed association election that rode in on Kestrel’s Form 2553 starts that clock as surely as a filed form would have. Kestrel’s election took effect in early 2023, the 60 months run into 2028, and the deal is signing in 2026.

That conclusion depends on Kestrel having operated as a partnership before its S election. An election by a newly formed eligible entity that is effective on its date of formation is expressly excluded from the 60-month limitation.

The regulation provides a limited exception: the Commissioner may permit an early classification change where more than 50% of the ownership interests satisfy the regulation’s new-owner test. But the relief is discretionary and ordinarily would have to be pursued through a private-letter ruling, which is hardly an attractive solution in the middle of a live deal. The cleaner answer is to avoid the second classification election altogether.

Nor can the parties simply skip step three and sell the QSub as is, because Kestrel’s elected corporate classification would follow it out the door at closing, and the buyer would find itself holding a corporation rather than the transparent entity its model priced.

The fix and what the fix costs

The escape is mechanical. The holding company forms a brand-new limited liability company, an entity that has never elected anything and is therefore disregarded by default. Kestrel then merges into the new LLC under state law, with the new LLC surviving. Within the structure, the merger of one disregarded arrangement into another is a nonevent for federal income tax purposes; the reorganization completes, and the buyer purchases interests in a disregarded entity exactly as the model assumed. No second classification election is made, so the 60-month limitation is never implicated.

The merger route is not merely a practitioner workaround. Treas. Reg. Section 1.1361-5(b)(3), Example 2, expressly contemplates an S corporation parent causing its QSub to merge into a wholly owned disregarded LLC as part of a planned sale of LLC interests. The regulation disregards the deemed corporate formation and merger under step-transaction principles, leaving the operating assets in the disregarded LLC immediately before the sale.

New York practitioners also run the merger route as a matter of course, because a New York corporation cannot convert into an LLC and can only merge into one, so even a target with no election history at all ends up with a new surviving entity and a new EIN. The 60-month rule pushes Kestrel to the same result.

The cost is the very thing the regular sequence preserves. The surviving company is a new legal entity, and a new legal entity means a new EIN. Every administrative thread that Rev. Rul. 2008-18’s regular steps leave undisturbed now must be re-tied: payroll accounts re-established, state tax and unemployment registrations refiled, licenses and permits reviewed for whether they survive a merger, customer and government vendor files updated, banking arrangements moved. Contracts deserve a careful read as well, since a state-law merger can trip anti-assignment provisions that a QSub election never would have touched. None of it is fatal, but all of it takes time and coordination that a deal calendar rarely offers, and some of it, in regulated or government-facing businesses, takes far longer than the parties expect.

The diligence lesson compresses into two early questions: How did this target come to be an S corporation, and where is it organized? A Delaware corporation that elected S years ago follows the regular sequence. An LLC that changed from partnership or disregarded status to S corporation status inside the last five years or a New York corporation of any vintage means a merger, a new EIN, a longer administrative runway and a conversation with the buyer that should happen at the letter of intent rather than the week of closing.

The broader point

Cross-border deals for U.S. targets keep producing problems like this one, where a routine structure collides with a target’s election history in the middle of a signing calendar. Working through those collisions is what International M&A and Joint Ventures: Key U.S. Taxation Issues was written to do. The treatise follows transactions like Kestrel’s in its case studies from the first structuring call to the flow of funds, and its practice aids include a tax due diligence checklist that asks, among much else, how the target became an S corporation. Knowing where the standard steps fail and what the fix will cost comes from doing deals, and that experience is what I tried to put on the page.

International M&A and Joint Ventures: Key U.S. Taxation Issues

International M&A and Joint Ventures: Key U.S. Taxation Issues examines the U.S. tax implications of cross-border mergers, acquisitions and joint ventures from planning and due diligence through structuring, negotiation and post-closing considerations. The treatise includes practical analysis, case studies, tax due diligence checklists, sample acquisition agreement provisions and guidance on tax insurance and risk allocation to help practitioners navigate international transactions. The title is available in multiple formats on the LexisNexis Bookstore.

About the Author

Douglas S. Stransky, J.D., LL.M. (Taxation), is a partner and the leader of the Tax Practice Group at Sullivan & Worcester LLP in Boston, where he has practiced for nearly two decades. He concentrates his practice on international tax planning, with a particular emphasis on cross-border mergers and acquisitions, joint ventures and corporate restructurings. He is a Lecturer in Law in the Graduate Tax Program at Boston University School of Law, where he has taught corporate and international tax courses for over 15 years. Stransky is the author of International M&A and Joint Ventures: Key U.S. Taxation Issues, a LexisNexis treatise that examines the U.S. tax considerations involved in cross-border mergers, acquisitions and joint ventures.