File Memorandum

Date:               8/12/2015 10:47:00 AM

By:                  David Glenn

Client:            John Doe

Re:                  Formless LLC Conversion to Corporation

 

Facts:

  • John Doe has three Limited Liability Companies (LLC) organized in his home state.
  • They’re called LLC 1, LLC 2, and LLC 3
  • LLC 1 is a single-member LLC (SMLLC) and John is the sole member.
  • John has not elected for LLC 1 to be classified as a corporation under §301.7701-2(b)
  • LLC 1 has its own EIN
  • LLC 2 is a multi-member LLC and is taxed as a partnership
  • LLC 3 is a multi-member LLC and is taxed as an S-corporation
  • John’s home state allows LLCs to perform a formless conversion whereby they can convert from an LLC under state law to a corporation under state law
  • John wants to convert all three LLCs to state law corporations
  • Each LLC has $100 in assets (cash), $200 in debt, and ($100) in equity on its tax basis balance sheet

Issues:

1.  Will converting each LLC to a state law corporation create a taxable event?

2.  Can each LLC retain its existing EIN?

 Analysis:

1.  LLC 1 Conversion –

  • §301.7701-3(a) provides that “a business entity that is not classified as a corporation under §301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes as provided in this section.
  • §301.7701-3(b)(1)(ii) provides that if an “eligible entity” (an LLC) has a single owner it is disregarded as an entity separate from its owner.
  • §351 provides that no gain or loss shall be recognized on the transfer of property to a corporation in exchange for stock and the transferor is in control of the corporation after the transfer.
  • §357(c) provides that, where §351 applies, the transferor shall recognize gain on the transfer to the extent that the liabilities transferred to the corporation exceed the adjusted basis of the property transferred.
  • §301.6109-1(h)(2) provides that an entity previously disregarded under §301.7701-3 may keep its EIN, if it had one, when it becomes recognized as a separate entity for federal tax purposes. If it did not have an EIN but was using its owner’s TIN, it needs to now obtain its own EIN.
  • Because LLC 1 is disregarded for federal income tax purposes, the formless conversion under state law is treated as the formation of a new corporation. This means that the assets and liabilities are contributed to the corporation in exchange for its stock.

2.  LLC 2 Conversion –

  • Rul. 2004-59 provides that when an entity classified as a partnership for federal tax purposes converts into a state law corporation under a state law formless conversion statute, the following is deemed to occur –
  • Partnership contributes all of its assets and liabilities to the corporation in exchange for stock in the corporation
  • Immediately after the transfer, the partnership liquidates by distributing the stock in the corporation to the partners
  • §351 provides that no gain or loss shall be recognized on the transfer of property to a corporation in exchange for stock and the transferor is in control of the corporation after the transfer.
  • §357(c) provides that, where §351 applies, the transferor shall recognize gain on the transfer to the extent that the liabilities transferred to the corporation exceed the adjusted basis of the property transferred.
  • §301.6109-1(h)(1) provides that an entity that has an EIN will retain its EIN if its tax classification under §301.7701-3 changes

3.  LLC 3 Conversion –

  • §301.7701-2(b)(1) provides that a corporation is any business entity organized under a Federal or State statute if the statute describes the entity as incorporated or as a corporation, body corporate, or body politic
  • §301.7701-2(b)(2) provides that the term corporation means an association.
  • §301.7701-3(c)(1)(v)(C) provides that an eligible entity that elects S corporation status is treated as having made an election to be classified as an association.
  • By virtue of electing S corporation status, LLC 3 meets the definition of a corporation for federal income tax purposes. By changing its state law entity to a corporation, it still meets that definition.

 Conclusion:

1.  Will converting each LLC to a state law corporation create a taxable event?

  • LLC 1 – John Doe will recognize gain of $100 under §357(c).
  • LLC 2 – Gain of $100 will be recognized by the partnership under §357(c)
  • LLC 3 – No gain or loss will be recognized

2.  Can each LLC retain its existing EIN?

  • LLC 1 – Yes it should
  • LLC 2 – Yes it should
  • LLC 3 – Yes it should