Merger Undertaken to Qualify for S Election Qualifies as F Reorganization.

• Author: Weinberger, Mark

A district court has stated that a merger undertaken solely to make an S election was nevertheless a reorganization. The court also ruled that accounting fees incurred when the C corporation merged into a newly formed S corporation were not ordinary and necessary business expenses and must be capitalized (United Dairy Farmers, 107 F Supp2d 937 (DC Ohio 2000)).

Background

The IRS has issued several letter rulings approving reorganizations undertaken to make an S election; see Letter Rulings 8806074, 8631058, 8541034, 9104009 and 8942091. However, in each of these rulings, the taxpayer asserted that the transaction was also undertaken to simplify operations or reduce administrative or accounting expenses.

Facts

To change from a C corporation to an S corporation, United Dairy Farmers (UDF) formed an S corporation, Uncle Bud's Fried Dough, Inc. (UBFD). UDF merged into UBFD. After the merger, UBFD changed its name to United Dairy Farmers. The sole purpose of the merger was to make an S election and thereby reduce the individual shareholder's tax liability. (The facts cited by the court do not indicate why the merger was necessary to effect the S election.) The merger did not change UDF's corporate structure, assets or business operations. No facts were presented identifying expenses to be reduced by the merger.

UDF paid $46,300 for accounting fees associated with the merger. UDF deducted that amount on its 1993 corporate tax return, arguing that the fees were tax...