Tax Restructuring: Strategies, Objectives, and Process

Tax restructuring is the process of modifying a business’s or individual’s legal, ownership, or operational framework to enhance tax efficiency. It is a proactive measure to improve financial outcomes by aligning a financial structure with the most favorable provisions of the tax code. This process involves a deliberate review and alteration of how assets are held, income is generated, and the overall enterprise is legally organized to support growth and minimize tax liabilities.

Core Objectives of Tax Restructuring

Tax restructuring is driven by several objectives. These include:

• Lowering the overall effective tax rate by arranging business affairs to minimize the percentage of income paid in taxes.
• Deferring tax liability to a future year, which preserves cash for short-term reinvestment and growth.
• Preparing for the sale or acquisition of a business to maximize after-tax proceeds for a seller or create future tax deductions for a buyer.
• Facilitating efficient estate and succession planning to transfer assets to the next generation while minimizing federal estate and gift taxes.
• Unlocking cash trapped within a corporate structure, particularly in a multinational context, to make funds available for domestic investment or distribution.

Business Tax Restructuring Strategies

Entity Selection and Conversion

A company’s legal entity type is a foundational element of its tax strategy. The primary structures—C corporations, S corporations, and partnerships or limited liability companies (LLCs)—have different tax characteristics. A C corporation pays tax at the corporate level, and shareholders pay a second tax on dividends. S corporations and partnerships are pass-through entities, where profits pass directly to the owners’ personal tax returns, avoiding an entity-level tax.

A common move is converting a C corporation to an S corporation to eliminate this double-taxation. To make this change, the corporation must file an election with the IRS. This is only available to domestic corporations with no more than 100 shareholders, who must be individuals, certain trusts, or estates, and have only one class of stock.

This conversion can have consequences. A C corporation that converts may be subject to the built-in gains (BIG) tax if assets that appreciated in value while it was a C corporation are sold within five years of the S corporation election. The BIG tax is imposed at the highest corporate tax rate on the gain that existed at the time of conversion.

Conversely, a pass-through entity might become a C corporation. This can be advantageous for companies seeking to raise capital from venture capitalists, who often prefer investing in C corporations. It also allows a business to use certain tax deductions and can be beneficial for retaining earnings for reinvestment.

Tax-Free Corporate Reorganizations

Corporate reorganizations allow businesses to change their structure without an immediate tax cost by deferring gain or loss on the exchange of stock or assets. The principle is that the transaction is a change in the form of an investment, not a liquidation of it.

A statutory merger or consolidation, known as a Type “A” reorganization, involves one corporation acquiring another, with the target’s shareholders receiving stock in the acquiring corporation. If requirements like continuity of interest are met, shareholders do not recognize immediate gain. This is often used to combine two companies into a single entity.

An asset-for-stock acquisition, or a Type “C” reorganization, occurs when one corporation acquires substantially all assets of another in exchange for its voting stock. This can be useful when the acquiring company wants the target’s assets but not its potential liabilities.

Divisive reorganizations, such as spin-offs and split-offs, allow a single corporation to be broken into two or more separate entities tax-free. In a spin-off, a parent corporation distributes a subsidiary’s stock to its shareholders. In a split-off, shareholders exchange some of their parent stock for the subsidiary’s stock.

Asset vs. Stock Transactions

When a business is sold, the structure of the sale as either an asset or stock transaction has significant tax consequences for the buyer and seller. This choice is a central point of negotiation that impacts the seller’s after-tax proceeds and the buyer’s future tax benefits.

In a stock sale, the seller sells their shares in the corporation to the buyer. For the seller, this is often preferred, as the gain is typically a long-term capital gain subject to a single level of tax at preferential rates. The transaction transfers the entire entity, including all assets and liabilities.

In an asset sale, the selling corporation sells its individual assets to the buyer. For a C corporation seller, this structure can create double taxation. The corporation first pays tax on the gain from selling its assets, and shareholders pay a second tax when the proceeds are distributed.

From the buyer’s perspective, an asset sale is preferable because the buyer receives a “step-up” in the tax basis of the purchased assets to their fair market value. This higher basis allows for larger depreciation and amortization deductions, reducing future taxable income. In a stock sale, the tax basis of the corporation’s assets remains unchanged.

Individual and Estate Tax Restructuring

The Use of Trusts

Trusts are a fundamental tool for individual tax restructuring, allowing for the management and transfer of assets. A trust is a legal arrangement where a trustee holds assets for a beneficiary, and its tax implications depend on whether it is revocable or irrevocable.

A revocable trust, or living trust, allows the creator (grantor) to retain control over the assets. For tax purposes, all income is reported on the grantor’s personal tax return, and the assets remain part of the grantor’s taxable estate. Its primary purpose is to avoid probate, not to reduce taxes.

An irrevocable trust cannot be easily altered by the grantor. When assets are transferred to an irrevocable trust, the grantor gives up control, and the transfer is considered a completed gift. The benefit is that the assets and any future appreciation are removed from the grantor’s taxable estate.

Certain irrevocable trusts serve specific goals. An Irrevocable Life Insurance Trust (ILIT) is created to own a life insurance policy. By housing the policy in an ILIT, the death benefit proceeds are not included in the deceased’s taxable estate, allowing the full amount to pass to beneficiaries free of estate tax.

Family Limited Partnerships (FLPs)

A Family Limited Partnership (FLP) is an entity used in estate and gift tax planning to transfer family wealth across generations. Senior family members contribute assets like real estate or securities in exchange for partnership interests, which are divided into a small general partner interest (retaining control) and a larger limited partner interest.

The primary function of an FLP is to transfer wealth efficiently. Senior family members can gift limited partner interests to their children over time, using the annual gift tax exclusion to avoid gift tax or using their lifetime exemption.

A tax advantage of an FLP stems from valuation discounts. Because the gifted limited partner interests lack marketability and control, their value for gift tax purposes can be discounted. This allows senior family members to transfer more wealth while using less of their lifetime gift tax exemption.

The operation of an FLP requires adherence to legal and tax formalities. The partnership must have a legitimate business purpose beyond tax avoidance, such as centralized asset management or liability protection, to withstand potential IRS scrutiny.

Strategic Gifting Programs

A strategic gifting program is a component of many individual tax plans designed to reduce the size of a future taxable estate. This strategy uses the annual gift tax exclusion and the lifetime gift and estate tax exemption to transfer wealth during an individual’s lifetime.

The annual gift tax exclusion allows an individual to give up to a specific, inflation-adjusted amount to any number of people each year without paying gift tax. For 2025, this amount is $19,000 per recipient. A married couple can combine their exclusions to give double that amount.

Each individual also has a large lifetime gift and estate tax exemption. For 2025, this exemption is $13.99 million per person, but it is scheduled to revert to an inflation-adjusted amount of approximately $7 million in 2026. A key strategy is to use this exemption to gift assets expected to appreciate, removing both the current value and future growth from the taxable estate.

Direct payments for tuition and medical expenses are another gifting tool outside of these exemption limits. Payments made directly to an educational institution for tuition or to a medical provider for healthcare are not considered taxable gifts, allowing for substantial support without impacting exemptions.

The Tax Restructuring Process

Analysis and Planning

The first phase of tax restructuring is analysis and planning. This involves gathering several years of historical financial statements, current corporate or operating agreements, and prior tax returns for the business and its owners to establish a baseline.

Next, financial models are created to project the tax consequences of various restructuring alternatives. For example, if a business sale is contemplated, models would compare the after-tax proceeds from an asset sale versus a stock sale. This analysis is often supplemented by a formal business valuation.

This phase concludes with the selection of the optimal path, documented in a plan that outlines the chosen strategy, expected benefits, an implementation timeline, and identified risks. This plan serves as the roadmap for the process.

Implementation and Compliance

Once a plan is finalized, the process moves to implementation. This involves drafting and filing legal documents with state authorities, such as articles of merger to combine companies or a certificate of conversion to change an entity’s legal form.

A parallel action is making required tax elections with the IRS by filing specific forms. For example, an S corporation election is made by filing a specific form, while an LLC choosing to be taxed as a corporation files an entity classification election. These forms have strict deadlines that must be met.

After filings are complete, the company’s internal accounting and record-keeping systems must be updated to reflect the new structure. This includes changes to financial reporting and ownership records. The changes must also be communicated to external stakeholders like banks, lenders, and key customers.