Passthrough Partner. Mergers and Conversions Statutory Authority and Federal Taxation How You Do It Can Make a Difference. By J.

Passthrough Partner Mergers and Conversions Statutory Authority and Federal Taxation How You Do It Can Make a Difference By J. Leigh Griffith J. LEIGH GRIFFITH, J.D., LL.M., CPA, is a Partner at Waller Lansden Dortch & Davis, LLP, in Nashville, Tennessee. T his column summarizes the different methods and tax consequences whereby a partnership or other unincorporated entity (1) becomes a corporation for state law and federal and state tax purposes, or (2) remains a state law partnership or other unincorporated business entity but becomes taxable for federal (and often state) tax purposes as an association taxable as a corporation. The different methods of incorporating an LLC may cause different amounts of Code Sec. 357(c) gain to be recognized by the members and may change the tax basis of the assets in the corporation. on The actual longhand transfer of assets s and liabilities involving ving the distribution of Code Sec. 704(c) property from a partnership to its partners will trigger rgain to the contributing ing partner. 1 Whereas the incorporation of a partnership by any method of incorporation (other than a method involving an actual distribution of partnership property to the partners followed by a contribution of that property to a corporation), followed by the partnership s liquidation as part of the incorporation transaction will not trigger such gain. 2 The state law ability to change from one form of state law business entity into another (partnership to corporation or corporation to partnership) and the tax law ability of a noncorporate business entity simply CTB to be treated as a corporation or a partnership for federal income tax purposes provides a massive amount of flexibility to the taxpayer and the business planner. The ease under state law by which a limited liability company (LLC) 3 can become a corporation under state law (or CTB to be treated as an association taxable as a corporation for federal income tax purposes) or by which a corporation can become an LLC or other unincorporated entity is deceptively simple. The tax consequences, however, are not simple and perhaps expensive. 4 The actual change in form of an entity can also cause significant changes to the rights and duties of the parties and governance structure. Often taxpayers do not focus on these aspects when actually going from one form of state law entity to another. The CTB ease for a partnership to elect to be treated as an association taxable as a corporation or once taxable as a corporation to become taxable as a partnership by merely the filing of a form AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 21

PASSTHROUGH PARTNER belies the seriousness of such actions and is frequently implemented by taxpayers without an understanding of the tax ramifications. Appendix I of this column presents in tabular form the applicable state laws for the merger of LLCs into corporations and Appendix II presents in tabular form the applicable state laws for the conversions of LLCs into corporations. This column explores and summarizes the tax ramifications of (1) an LLC taxable as partnership actually becoming a corporation under state law, and (2) an LLC electing to be treated as an association taxable as a corporation but retaining its state law LLC form. While the column is focused on LLCs, 5 the federal tax principles are of general application to all unincorporated business entities taxable as partnerships. The terms partnership and partner are sometimes used to match the terminology of the Code and Treasury Regulations rather than the state law terms of LLC and member which are the terms used predominately in this column as the LLC is the predominate form of business. While most states characterize an LLC s income tax status in the same manner as the federal taxing authorities, some states without individual income taxes such as Alaska, New Hampshire, Tennessee, Texas and Washington 6 apply their corporate taxes to LLCs regardless of their federal tax classification. In the analysis below, for states that follow the federal tax law in characterizing the entity and imposing income tax at either the entity level or the member level, the federal tax discussion should be fully applicable. However, for states that apply their corporate taxes to LLCs, there may or may not be the state law equivalent of an F reorganization for mergers involving at least one noncorporate entity which is subject to the state s corporate tax. Tennessee nessee would impose its corporate taxes on an interspecies merger of an LLC into a corporation even though both are subject to Tennessee s corporate tax. Corporate and other state taxes may exist in other transaction variations, such as when the entity distributes or is deemed to distribute its assets to its members as part of the incorporation process. The physical transfer of assets, if such occurs, will often have state transfer tax ramifications. A specific state tax analysis is beyond the scope of this column. From a tax perspective, it is easier (more tax friendly) to go from an LLC to a corporation than to go from a corporation to an LLC. The author s corporate tax professor at NYU, the late Jim Eustice, used to say: A corporation is like a lobster pot. It is attractive to the lobsters, fairly easy to get into, difficult to survive in and da[r]n 7 near impossible to get out without being eaten. Today, with the 2014 new individual tax rates and the net investment income tax, many are reconsidering the use of C corporations versus LLCs. Whether making the decision to change from an entity doing business in a form taxable as a partnership to doing business in an entity taxable as a corporation is a good or bad idea is beyond the scope of this column. The decision is often rather factually driven. The applicable state taxes to the ongoing enterprise, the impact on basis, holding period, and the taxes on a later sale will often be of critical importance for making such a decision. The flexibility of an LLC versus the rigidity of governance and distributions are business considerations that enter into the equation. There are generally three methods for an LLC to become a corporation under state law: 1. The first is a longhand series of transactions. These involve the old fashioned transfer of assets and liabilities or interest between or among parties. There are three varieties of longhand. The (1) assets up whereby the LLC actually distributes its assets and rearrange liabilities to its members who then actually contribute such assets and liabilities to the corporation; (2) assets over whereby the LLC contributes the assets and liabilities to the corporation in exchange for stock and then distributes the corporate stock to its members in liquidation; and (3) interest over whereby the members actually transfer their membership interests to a corporation in exchange for stock. 8 2. The second is by a state law interspecies or formless merger whereby the LLC merges into the corporation. 3. The third is by conversion whereby eby the LLC complies with the state law requirements to simply convert to a corporation. on In the conversion n process, generally ly the corporation will be deemed to be a continuation of the prior LLC. Longhand Transactions. Rev. Rul. 84-111 9 permits the taxpayer to choose the tax consequences of a partnership incorporation transaction in which assets and liabilities or the interests are transferred by actually structuring the transaction in one of the three different ways identified above and discussed below. Assets Over Transfer of Assets and Liabilities by the LLC to the Corporation and the Subsequent Liquidation of the LLC and Distribution of Stock to the Members 10 The longhand assets over approach, whereby the LLC actually transfers the specific assets and liabilities to the corporation in exchange for stock, is done at the entity 22 TAXES The Tax Magazine AUGUST 2014

TABLE 1. ASSETS OVER LLC TRANSFERS ASSETS AND LIABILITIES TO CORPORATION AND LIQUIDATES Gain or loss on contribution of assets and liabilities to corporation by LLC. Basis of assets in hands of corporation and basis of stock in hands of LLC. Holding period of assets by corporation and stock by LLC. Gain or loss N/A on distribution of stock in liquidation of fllc and receipt eipt of stock by members. mbers. Holding period of stock by now former members. Corporation LLC Members No gain or loss Code Sec. 1032(a). Basis of assets in hands of LLC plus gain recognized by LLC. Code Sec. 362(a). Note aggregate basis of assets in hands of corporation cannot exceed FMV of assets (Code Sec. 362(e)) unless election under Code Sec. 362(e)(2) is made to reduce basis of stock. Tacked holding period (i.e., holding period of assets held by LLC). Code Sec. 1223(2). Per Code Sec. 351(a), no gain or loss (i) unless corporation is an investment co (Code Sec. 351(e)), or (ii) liabilities transferred exceeds basis of assets transferred (Code Secs. 3F51(b)(1) and 357(c)). Note: via Code Sec. 357(a), the assumption of liabilities is not receipt of money for Code Sec. 351 boot purposes, but is controlled by Code Sec. 357(c). Basis of stock in hands of LLC is the basis of assets transferred reduced by liabilities assumed which is a deemed payment of money under. Code Sec. 358(d) plus any gain recognized by the LLC. 358(a) and (d). Holding period for stock received for capital and 1231 assets is LLC s holding period for such assets. Code Sec. 1223(1). Holding period for other assets starts day after contribution to corporation. Rev. Rul. 84-111 and Rev. Rul. 70-598. No gain or loss on distribution of property in liquidation. Code Sec. 731(b). LLC terminates under Code Sec. 708(b)(1)(A). ( Per Rev. Rul. 84-111, distribution in liquidation of partnership rship will not violate control requirement remen of Code Sec. 368(c). Corporation assumption of LLC liabilities relieves the LLC of debt and causes a deemed distribution to the members under Code Secs. 732 and 752. This reduces basis in the LLC interest and triggers gain if the deemed distribution is greater than basis. By virtue of the contribution of assets to a corporation in a Code Sec. 351 exchange, any gain recognized by the LLC flows to members and increases basis of membership interest. Code Secs. 705(a) and 752(b). N/A No gain or loss on receipt of stock in liquidation of LLC unless money distributed exceeds basis. Code Sec. 731(a) N/A N/A The now former members holding period will be the LLC s holding period (or deemed holding period) of the stock. Code Sec. 735(b). Basis of stock in hands of member following liquidation of LLC The LLC s holding period for stock received for Code Sec. 1231 and capital assets held by LLC includes the period the LLC held such assets. Code Sec. 1223(1) For all stock received by the LLC for other property such as inventory. Rev. Rul. 84-111. Rev. Rul. 70-958. NA NA Adjusted basis of stock in hands of member is basis of member s LLC interest immediately prior to liquidation after accounting for income, gain, loss and expenses for tax year ending on date of liquidation. Code Sec. 732(b). This basis has been reduced for the liabilities assumed by the corporation, which is considered the payment of money. Code Secs. 732(d) and 358(d). AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 23

PASSTHROUGH PARTNER level and therefore the cooperation of each member is not required. Rather, an action by the relevant officers or managers of the LLC with the requisite approval of the members is all that is required. 11 Since the transfer is part of a transaction that will cause the LLC to cease its business activities and perhaps liquidate, many state default statutes require a super majority vote ( e.g., Delaware 12 ) while other state default statutes may only require a majority in interest ( e.g., Tennessee 13 ) to approve a liquidation or the disposition of all or substantially all of the assets of the LLC. In accordance with the terms of the operating agreement and perhaps other governing documents, the requisite approvals must be obtained and the transaction will be implemented by the LLC. A substantial disadvantage is that the actual transfer of the assets and liabilities may require approval of creditors or lessors, trigger transfer taxes, etc., all of which increase the transaction costs and may inhibit or prevent the transaction. In the assets over transactions there is one transferor, the LLC. Each member is not a separate transferor. The basis of the assets contributed to the corporation is the basis of the LLC or inside basis, not the basis of the members in their membership interest. The transfer of the liabilities to the corporation will represent a distribution of money to the member in accordance with such member s interest in the liability. lity. If no Code Sec. 754 election has been made, the LLC s LC business and activities have appreciated in value and there have been transfers of membership interests, ts counsel should explore an assets up form of incorporation n as the outside basiss is most likely higher than the inside basis. As discussed later herein, the assets over federal income tax results easily can be obtained by other means such as a conversion or merely CTB. The Treasury and IRS appear to favor the assets over paradigm, 14 although they did change Rev. Rul. 70-239 15 to follow the form the taxpayer actually used in Rev. Rul. 84-111. 16 The federal income tax effects of the assets over approach are summarized in Table 1. Assets Up Liquidation of LLC and Transfer of Assets and Liabilities by the Members to the Corporation This is commonly referred to as the assets up technique as the assets and liabilities are distributed up to the members in the first step. The actual liquidation of an LLC s assets and liabilities to its members, their subsequent contribution to a corporation, and the corporation s assumption of debt in exchange for stock involves multiple asset transfers, exposes the members to personal liability, requires the timely and affirmative action of all members, may require lender and other contractual parties consents, and is therefore rarely used. There may be multiple state and local transfer taxes and various recording taxes triggered by such transfers. Perhaps most importantly is the members may inadvertently be subject to enterprise liabilities they would have not been exposed to without the momentary instance of being an actual direct owner. The logistics and liability complexity generally made this long hand technique unattractive for most situations. If a member has contributed appreciated property in the past seven years (referred to as 704(c) property) and such property is actually distributed from the LLC to other members in the implementation of an assets up transaction, unrecognized gain and tax under Code Sec. 737 will be triggered. 17 The assets up transfers for federal tax purposes may be accomplished on a deemed basis to avoid these additional complexities, including avoiding the gain and tax under Code Sec. 737 for the original transferor member. 18 The distribution of all the LLC s assets to its members terminates the LLC for tax purposes. 19 The decrease in the LLC s liabilities as a result of their transfer to the members is a deemed distribution of money, which reduces the basis of each member. This is offset by the members corresponding assumption of such liabilities, which increases basis so the net effect on the members basis with respect to such liabilities is zero. However, if a member had used some of the basis s supported by such debt, i.e., had a negative capital account, the member will recognize gain as the deemed distribution of money will exceed basis. For most LLCs, most of the gain will be capital gain, however, the gain associated with unrealized receivables and inventory and other Code Sec. hot assets will generate ordinary income. 20 The federal tax consequences of the assets up approach (whether actual or deemed) are summarized in Table 2. Interest Over Transfer of 100 Percent of the LLC Membership Interests to Corporation Referred to As Interest Over Th e transfer of LLC membership interests by the members to a corporation can be accomplished without exposing the members to additional personal liability. This longhand approach requires each member to timely transfer his membership interest in conjunction with the transfers of all others. Sometimes there are a few 24 TAXES The Tax Magazine AUGUST 2014

TABLE 2. ASSETS UP ASSETS AND LIABILITIES ARE DISTRIBUTED TO MEMBERS AND CONTRIBUTED BY THE MEMBERS TO THE CORPORATION Gain or loss on distribution of assets and liabilities from LLC to members. Corporation LLC Members N/A No gain or loss on transfer of assets and liabilities to members in liquidation of the LLC. Code Sec. 731(b). The transfer of all assets to the members terminates the LLC for tax purposes. Code Sec. 708(b)(1)(A). Generally no gain or loss on receipt of assets and assumption (or taking assets subject to) liabilities. However, members recognize gain to extent the amount of money (including marketable securities) distributed or deemed distributed exceed a member s basis in his membership interest immediately before the liquidation after taking into account income, gain, etc. for short year ending with the liquidation. Code Sec. 731(a). Character of income and gain is controlled by Code Secs. 741 and 751. If appreciated property had been previously contributed to an LLC and is distributed to members other than the contributing member within 7 years of contribution, the contributing member recognizes unrealized original gain. Code Secs. 704(c)(1)(B) and 737. If 704(c)(1)(B) and 737 property are only deemed distributed in a transaction incorporating a partnership, gain will not be triggered if the partnership liquidates. Treas. Reg. 1.704-4(b)(5) and 1.737-2(c). Holding period for assets distributed to members. Basis of assets s in hands of members. N/A N/A Holding period for assets received by members includes the period the LLC held the assets. Code Sec. 735(b) N/A N/A Adjusted basis of member s membership interest est immediately prior to liquidation after accounting for income, gain and loss and other distributions for year ending with liquidation, decreased by amount of money received or deemed received. Code Sec. 732(b). Note, if member acquired by transfer LLC interest within two years and no Code Sec. 754 election, may elect to have basis as if Code Sec. 754 election was made. Code Sec. 732(d). The basis of each property is determined under Code Sec. 732. Gain or loss on transfer of assets and liabilities to the corporation in exchange for stock and issuance of stock. No gain or loss. Code Sec. 1032. N/A Under Code Sec. 351(a), no gain or loss to members on transfer of assets and liabilities to corporation unless corporation is an investment company (Code Sec. 351(e)) or amount of liabilities transferred exceeds tax basis of assets transferred. Code Secs. 351 and 357. Note: via Code Sec. 357(a), the assumption of liabilities is not the receipt of money for purposes of Code Sec. 351, but is a liability for Code Sec. 357(c). Code Sec. 358(d). AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 25

PASSTHROUGH PARTNER TABLE 2. ASSETS UP ASSETS AND LIABILITIES ARE DISTRIBUTED TO MEMBERS AND CONTRIBUTED BY THE MEMBERS TO THE CORPORATION (CONTINUED) Basis of assets in hands of corporation and basis of stock in hands of members. Corporation LLC Members Basis of assets in hands of members immediately prior to transfer plus gain recognized by members as result of transfer to the corporation. Code Sec. 362(a). The basis of the assets reflects the member s prior basis in the membership interest before the actual or deemed distribution in liquidation of the LLC adjusted for deemed distribution of money. Note aggregate basis cannot exceed FMV of membership interests unless election is made to adjust basis of membership interest. Code Sec. 362(e) N/A Basis of stock received is equal to basis of assets contributed to corporation reduced by liabilities assumed by the corporation or secured by the transferred assets and increased by gain recognized on transfer of assets to corporation. Code Sec. 358(a). Note, the basis of the assets reflects the basis of the membership interest prior to the distribution of such assets to the member adjusted for deemed distribution of money. Code Sec. 732(b). If basis of assets transferred to the corporation is greater than the FMV of such assets, shareholder and corporation can jointly elect to reduce the basis of the stock and retain the basis above FMV of the assets in the hands of the corporation. Code Sec. 362(e). Holding period for corporation assets and or stock of corporation. Same as holding period of assets contributed by members which is generally the holding period of the LLC of the assets immediately prior to the distribution to the members in liquidation of the LLC. Code Secs. 735(b) and 1223(2). N/A Stock received in exchange for capital assets or Code Sec. 1231 assets will have a holding period for shareholder which includes holding period of the assets transferred. Code Sec. 1223(1) Since assets were received by member in liquidation of membership interest in the LLC, under Code Sec. 735(b) the holding period of such assets which are capital al assets or Code Sec. 1231 assets was the holding period of the LLC with respect to such assets. Stock received for other assets such as inventory, and other Code Sec. 751 hot assets will have holding period for beginning day after contribution. Rev. Rul. 84-111 and Rev. Rul. 70-598. members who do not wish for the LLC to be taxable as a corporation and refuse to transfer their interests. Sometimes members change their minds or for one reason or another are unwilling or unable to timely transfer their interests even though they agreed to the transfer. An incomplete transfer ( i.e., less than 100 percent of the membership interest) may have unpleasant business governance consequences. 21 From a legal and business perspective, the LLC continues to exist with the nontransferring members remaining as members and the corporation as another member (assuming the requisite consent for the corporation to be a member is obtained). 22 The governance of the LLC may have an election of a board by a per capita vote of the members. In such case, the corporation with perhaps the vast majority of ownership interest may have a single vote. For those and other reasons, other forms of accomplishing the incorporation may be preferred if there are multiple owners. Indeed as the number of owners increase, the preference for using other forms of implementation rises exponentially. From a tax analysis, there is a transfer in exchange for the stock of the corporation. However, as discussed below, the tax analysis is bipolar and confusing. Nevertheless, if all goes as planned, the corporation will own 100 percent of the LLC s membership interests making the LLC a single member LLC (SMLLC). A domestic SMLLC (by default) is a disregarded entity for federal (and often state) income tax laws, but remains 26 TAXES The Tax Magazine AUGUST 2014

a separate legal entity unless the LLC is actually liquidated under state law into the corporation. The SMLLC will generally file its own employment tax returns and other non-income tax returns. Surprisingly, the federal income tax analysis of 100 percent of the membership interests of an LLC being contributed to a newly formed corporation is a bit murky and presents some technical challenges to navigate. The IRS s basic analysis is provided in Rev. Rul. 84-111, which overturned Rev. Rul. 70-239. Rev. Rul. 70-239 provided that a transfer of partnership interests or assets however accomplished via a Code Sec. 351 transaction would be treated as a transfer of assets and liabilities by the partnership to the corporation in exchange for the stock in a Code Sec. 351 transaction followed by a distribution of the stock to its partners in liquidation of the partnership (an assets over transaction). In the scenarios of both of these rulings, the partnership debt did not exceed the basis of the partnership s assets and neither ruling addressed the impact of partnership debt in excess of basis. In addition, there were other aspects not covered by Rev. Rul. 84-111. These aspects were discussed in the earlier case of Mc- Causlen, 23 whose analysis was incorporated into Rev. Rul. 67-65. 24 Neither McCauslen nor Rev. Rul. 67-65 were referred to in Rev. Rul. 84-111. The IRS subsequently issued Rev. Rul. 99-6, 25 which clarified Rev. Rul. 84-111. Rev. Rul. 99-6 96 9-6 posits one approach for the members transferring ring their rm membership ership interests (a transfer of the membership mber interests) and another approach (a receipt of assets s and liabilities consistent ilities with the assets s over transaction) with respect to the corporation receiving the assets and dliabilities in the same transaction. While the analytics are confusing to follow, the ultimate result is a transfer of membership interests by the members and the corporation s receipt of the assets and liabilities of the LLC (not the membership interests). The member transfers the membership interest and avoids liquidating the LLC and the corporation receives assets and avoids liquidating the LLC. In essence, an LLC liquidation nobody claims is blessed by the IRS. Therefore, under Rev. Rul. 99-6, in order to analyze the federal tax effect of a transfer of the membership interests in an LLC to a newly formed corporation in a Code Sec. 351 transaction, there are two separate analyses that must take place. One analysis is for the members transferring their membership interests in a Code Sec. 351 transaction and the second is for the corporation acquiring the assets in a Code Sec. 351 transaction. They are different and they do not overlap. They do come to the result that the corporation has the assets and liabilities of the LLC and the members have their proportionate share of corporate stock. In the author s view, Rev. Rul. 99-6 fleshes out Rev. Rul. 84-111 and Rev. Rul. 80-323 26 provides the overlay for the treatment of the debt inside the LLC. In Rev. Rul. 80-323, the partners transferred their partnership interest (representing 35 percent of the partnership) to a corporation in a Code Sec. 351 exchange. The transfer of the 35 percent interest did not cause a termination of the partnership under Code Sec. 708. The ruling found that the share of partnership nonrecourse debt attributable to the partnership interest was considered a liability to which the partnership interest was subject for purposes of Code Sec. 357(c). The contribution of a membership interest carries with it an assumption of LLC debt related to such interest for purposes of Code Sec. 357(c). Rev. Rul. 84-111 in its Situation 3 views a Code Sec. 351 transaction wherein the members under state law transfer their membership interests to the corporation in exchange for corporate stock. It implicitly required the acquired membership interest to be held for a moment by the acquiring corporation, and then the assets be distributed to the acquirer in liquidation of the LLC. It states: On the transfer of the partnership interests to the corporation, Z (the LLC in our analysis) terminated under section 708(b)(1)(A) of the Code. 27 The specific analysis of Situation 3 did not discuss the LLC s debt or any debt of the transferring members transferred to the corporation. 28 The law and analysis portion of Rev. Rul. 84-111 states: Section 753(d) of the Code provides that in the case of a sale or exchange of an interest inapa partnership, rship liabilities shall be treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. 29 By virtue of the transfer of the membership interest, the member should recognize a deemed distribution of cash for the LLC s internal liabilities. This will reduce the basis of the membership interest in the hands of the member if the member s basis is greater than such debt or bring the member s basis to zero if the debt was greater than basis. The corporation receiving the interest would have the member s basis in the interest plus be deemed to make a capital contribution equal to the LLC debt associated with the interest. Although the corporation may be exposed to gain on the liquidation of the LLC when it holds the membership interest under Code Sec. 732(b) if the deemed distribution of money exceeded basis, but it is hard to see circumstances when that would occur in reality as a part of the incorporation process. From the transferring member s perspective, there is an exchange of his membership interest for stock. Just AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 27

PASSTHROUGH PARTNER as in any exchange of property for stock, the transferees as a group must have 80 percent or more in vote and value of the stock of the corporation for Code Sec. 351 to apply. 30 In such case each member will not recognize taxable gain unless the debt associated with his membership interest (both the share of LLC inside debt and any outside debt transferred with the interest) exceeds the basis of the membership interest. First the residual basis for the membership interest (basis of interest before consideration of the member s share of LLC debt) must be determined. If this basis is positive, the member will not recognize gain by virtue of a deemed distribution of money under Code Sec. 752(d) in excess of basis on the transfer of the membership interest under Code Sec. 731(a). If the deemed distribution of money exceeds the residual basis, then the member recognizes gain equal to such excess under Code Sec. 731(a). If there is additional debt associated with the membership interest that was outside the LLC and such debt when combined with the inside debt exceeds the basis after adjustment for the Code Sec. 731 gain, the transfer to the corporation will trigger gain under Code Sec. 357(c). This gain is equal to the aggregate debt over the basis of the membership interest after such basis is adjusted for the deemed distribution of money. 31 If the aggregate debt does not exceed basis, the transfer of the LLC membership mb interest to a corporation in a transaction tion qualifying for Code Sec. 351 treatment is not taxable. able. In the event that gain is triggered by either or both Code Sec. 731(a) or 357(c) (c), gain will be capital gain nexcept to the extent attributable to Code Sec. 751 hot assets via Code Sec. 751(a) look-through. For tax years beginning after 2012, the partnership interest is also looked through for purposes of determining 3.8-percent tax on the net investment income. The membership interest is also looked-through to see the underlying share of collectables and real estate with unrecaptured Code Sec. 1250 gain, which are subject to different capital gains rates. 32 In the absence of outside debt in excess of such residual basis being transferred, the member will not recognize gain on the transaction. Th e transferring member s basis will be the member s basis in the membership interest prior to the transaction plus the gain recognized in the transaction. 33 The member s holding period of the stock received for the membership interest attributable to capital assets and Code Sec. 1231 assets is the member s holding period for the membership interest. 34 Under Rev. Rul. 84-111, the member s holding period for other assets begins the day after the transfer. However, no authority is given for this position and one noted commentator refers to this aspect of Rev. Rul. 84-111 as questionable. 35 An analysis of the transaction from the corporation s perspective under Rev. Rul. 99-6 is receipt of assets and liabilities in exchange for the stock. However, to determine the basis and holding period of such assets, a hypothetical analysis of a liquidation of the LLC into the hands of the members and a contribution of the members to the corporation of the assets and liabilities must take place. This is the analysis of the assets up transaction described earlier. In the deemed distribution in liquidation to the members, the assets will assume the basis of the membership interest (this may be higher, lower or the same as the basis of the assets in the LLC). This basis will be decreased by the deemed distribution of money. 36 In the event the deemed distribution of money exceeds the basis a hypothetical gain is triggered 37 and brings the basis to zero, but no gain is actually triggered to the member, as this is only Rev. Rul. 99-6 s hypothetical transaction for purposes of determining the impact to the corporation. 38 The hypothetical basis in the hands of the member is now established. The hypothetical holding period of the assets in the hands of the members is the holding period of the assets in the hands of the LLC. 39 At this point in the Rev. Rul. 99-6 hypothetical transaction to determine the basis and holding period of assets received by the corporation, the members are deemed to contribute the assets and liabilities lities to the corporation ra o and the corporation receives the assets and liabilities. ie The corporation will not have gain norl loss under Code Sec. 1032. To the extent the aggregate debt (including both the previous inside debt and outside debt) that is assumed or the property is taken subject to exceeds the basis of the assets; a hypothetical Code Sec. 357(c) gain is triggered with respect to the transferring members, which increases the corporate basis of the assets. 40 Th e end result for the corporation is a basis in the assets it would have if there had been an assets up transaction. This is the hypothetical basis of the assets of in the hands of the transferring member which is the basis of the transferring member s membership interest immediately prior to the hypothetical deemed liquidation, 41 decreased for the deemed distribution of money from the LLC and increased by any Code Sec. 357(c) gain that would have been triggered. 42 The holding period for the assets would include the period the LLC held the assets. 43 The members are deemed to exchange their membership interests for stock. See Table 3 for a summary of the tax consequences of a contribution by the members of their membership interest in an LLC. 28 TAXES The Tax Magazine AUGUST 2014

TABLE 3. INTEREST OVER Gain or loss to members on transfer of 100% of membership interests to a corporation and gain or loss to corporation. Basis of assets in hands of corporation and basis of stock in hands of members. Holding period. Corporation LLC Members No gain or loss on exchange of stock for membership interest under Code Sec. 1032. Rev. Rul. 84-111 assumes the LLC continues for an instant when the corporation owns 100% of membership interests. Under Rev. Rul. 84-111, no gain or loss unless money received or deemed received in the LLC s liquidation exceeds the basis of LLC interest. Code Sec. 731(a). Under Rev. Rul. 99-6, the LLC is not acquired for a moment, only the assets. Therefore, no possible gain or loss to corporation. Under Rev. Rul. 99-6, from corporation s perspective treat as if the transaction was assets up. As a result, the corporation has members basis in LLC interests plus gain recognized but in absence of a Code Sec. 362(e) (2) election, limited to FMV of interests. Code Sec. 362(a) and 362(e). Under Rev. Rul. 84-111 the same result is reached with the exception the corporation would be the holder at the liquidation of the LLC. If somehow money distributed on liquidation exceeded basis of interest in hands of corporation the corporation would have gain. Per Rev. Rul. 84-111, the holding period would include the period the LLC held its assets. Code Sec. 735(b) Per Rev. Rul. 99-6, the holding period includes LLC s LC holding period for its assets. Code Secs. 735(b) and 1223(1). Under Rev. Rul. 84-111 and Rev. Rul. 99-6, the partnership interest is transferred by the members. N/A N/A Per Rev. Rul. 84-111 and consistent with Rev. Rul. 99-6, the members are treated as transferring membership interests. No gain or loss on transfer of membership interest to corporation in exchange for stock unless (i) the corporation is an investment company, Code Sec. 351, or (ii) LLC debt and debt associated with the interest and assumed or taken subject to by corporation exceeds the members basis (determined member by member). Code Sec. 357(c). Cf. Code Sec. 752(d) and Reg. 1.752-1(h) and 1.1001-2(a)(1). For character, see Code Sec. 741. Basis of stock received is equal to basis of the membership interest transferred to the corporation after taking into account the allocation of any income, gain, losses and distributions attributable to the interest for the LLC s tax year ending on the transfer reduced by the interest s share of LLC s liabilities and increased by gain recognized on transfer of the membership interest to corporation. Code Sec. 358(a). If basis of assets transferred to the corporation is greater than the FMV of such assets, shareholder and corporation can jointly elect to reduce the basis of the stock and retain the basis above FMV of the assets in the hands of the corporation. Code Sec. 362(e). For stock received for LLC interest other than interest attributable to Code Sec. 751 assets that are neither capital assets se nor Code Sec. 12311 assets, se the holding period of the membership interest is tacked for the stock. Code Sec. 1221(1). For stock received for interest attributable to Code Sec. 751 hot assets, the holding period begins day after transaction. Rev. Rul. 84-111 and Rev. Rul. 70-598. Note Rev. Rul. 84-111 gives no authority for the split holding period. Interspecies or Formless Merger As identified on Appendix I, most states will permit an LLC to merge into a corporation. In these states appropriate LLC and corporate actions are undertaken. Specific filings are generally made at the secretary of state s office. The result is the state law transfer of assets and liabilities from the LLC to the corporation, the LLC going out of legal existence, and the members receiving stock in exchange for their membership interest. This again is controlled at the entity level, and with the appropriate actions by the management of the LLC and the vote of the members of the LLC, the merger is implemented without further individual member action. Therefore, members not in favor of the business of the LLC being operated in a corporate format cannot stop the transaction if the appropriate votes are obtained. It is possible that some LLC state law default rules require unanimous consent while others require a simple majority. 44 In addition, state law is likely to give the members who are opposed to the merger dissenter s rights that will require the purchase of their interests. The LLC governing documents must also be examined to determine the requisite vote, as often the statutory requirement is a default rule or a minimum. 45 In a merger it is less likely that creditor and contractual consents are required; however, an examination of the specific documents should be undertaken to verify that a merger does not require a AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 29

PASSTHROUGH PARTNER consent or third party approval under those documents. In a merger the corporation has been separately formed and should have its own certificate of incorporation, bylaws and other corporate documentation that sets forth the governance structure, rights of the shareholders, classes of stock, etc. Each member should carefully review these documents, as various aspects of the LLC business deal may change as a result of the differences in the flexibility of the different forms of entities and different fiduciary and conduct standards may exist. If the retention of the LLC s federal identification number is required, but an assets up transaction is deemed a merger, as described below, will not be available alternatives for an F reorganization to occur which permits the corporation to retain the LLC s federal identification number, the LLC will need to CTB or otherwise become an association taxable as a corporation prior to the merger. Although a merger under state law, for federal income tax purposes a state law merger of an LLC taxable as a partnership is not a merger. Code Sec. 368(a)(1)(A) defines reorganization as a statutory merger or consolidation. Reg. 1.368-2 requires that the participants be corporations. Therefore, the merger of an LLC taxable as a partnership into a corporation is not a tax-free reorganization on under Code Secs. 354, 355, 356 and 368 and the tax implications ica of the merger must be analyzed under nonmerger rta tax rules. The merger authority that presently exists as to the federal eral tax treatment appears to be a single IRS letter ter ruling 46 in whichh a partnership merged into a subsidiary sidia of trust and received shares of the trust. The trust was a REIT and therefore a corporation for federal tax purposes. Without analysis, the IRS applied the assets over treatment to the merger. The partnership did not recognize any losses but recognized gain to the extent, if any, the liabilities assumed by the trust or trust subsidiary plus the liabilities to which the transferred assets were subject exceeded the total adjusted basis of the assets transferred. The LTR merely cited Rev. Rul. 84-111 (Situation 1). 47 See the tax analysis in Table 1 above. Some believe that the taxpayer may engage in self-help and consider scripting the events within a formless merger to take the position that an assets up scenario occurred based on the flexibility provided in Rev. Rul. 84-111. The assets are in fact being transferred to a new and different state law entity so the rationale of Reg. 301.7701-3(g)(1)(i) and Rev. Rul. 2004-59 do not necessarily apply. In the case of CTB and conversion 48 the entities remain the same and there is no transfer of the assets from one entity to another. Different practitioners may reach different conclusions as to the degree of authority the flexibility provided in Rev. Rul. 84-111 provides since it is discussing various forms of actual transfers and the tax ramifications therefrom. The practitioner, however, would not be disregarding a rule or regulation as that term is defined for Code Sec. 6694 and therefore not subject to potential penalty under Code Sec. 6694(a) or (b) of the greater of 50 percent of the fee or $1,000 or $5,000 respectively. In order to avoid the uncertainty surrounding a formless merger and the use of the assets up treatment, if all of the members are cooperative, an interest over approach should be used since Rev. Rul. 99-6 provides certainty. From the member side there is an exchange of membership interests for stock. Assuming the requirements of a Code Sec. 351 exchange are met, the taxable gain to each member is the amount by which, if any, the share of inside liabilities plus any outside liabilities the corporation assumes or takes the interest subject to over the tax basis of the membership interest. This is the same aggregate gain that the members would otherwise have from either an assets over or assets up transaction. From the corporation s standpoint, Rev. Rul. 99-6 characterizes the transaction as an assets up acquisition. If one or more members are unwilling to transfer their membership interests in such a manner, the recalcitrant members may be able to be forcibly redeemed under their LLC documents. This may be stressful and will likely take cash and greater transaction costs. Beware of the step transaction actio risk to the Code Sec. 351 treatment tmen if the uncooperative members mbers constitute 20 percent en or more of the membership interests. ts Unless other assets are transferred at such time to the corporation, the IRS may argue that the transferring members received less than the required 80 percent in vote and value. Conversion As set forth in Appendix II, many states permit an LLC to convert to a corporation. Generally, the converted entity is, for state law purposes, the same entity as the original entity. As a result there should be no transfer taxes and generally no consents or third party approvals required (unless the specific contracts expressly provide for consent or approval in the event of a conversion). It should be noted, however, that the state law form of the entity has changed. Applicable statutory fiduciary duties, indemnification, default rules for actions and governance will all apply unless documentation consistent with the new form is adopted. It is arguable that specific provisions in the operating agreement will carry over to the corporation if the applicable corporate law 30 TAXES The Tax Magazine AUGUST 2014

permits such provisions and new exclusive documentation is not adopted. However, it is recommended that new organic documents appropriate for the new legal form be adopted clearly setting forth the rights, duties, obligations and privileges of the shareholders, fiduciary duties of the officers and directors, governance provisions, and indemnifi cation provisions. Even if fully applicable, the prior documents may have implicitly incorporated the default rules of the original form of business entity which were not specifically addressed and the default rules of the new entity form will likely control and may be different. If the corporation is to be an S corporation, care should be taken that the surviving documents be consistent with the S corporation qualification requirements, the shareholders are qualified to be S corporation shareholders, the number of shareholders is compliant, and an S election is timely made. 49 Provisions in an operating agreement calling for special non pro rata distributions could be fatal. In Rev. Rul. 2004-59, 50 the IRS ruled that a conversion of a partnership to a corporation under a state law formless conversion statute was treated as an assets over transaction. See Table 1. This ruling acknowledges Rev. Rul. 84-111 and the three methods of incorporating a partnership. The ruling states Rev. Rul. 84-111 does not apply. 51 The ruling discusses Reg. 301.7701-3(g)(1)(i) 52 and di its CTB election, which mandates an assets over analysis. This ruling states tes that the assets over analysis applies plies and the conversion produces the deemed ed steps of (1) the partnership p contributing all of its assets and liabilities to the corporation o in exchange e for stock in nsuch corporation, and (2) immediately thereafter, the partnership liquidates distributing the stock of the corporation to its partners. It is doubtful that a court would permit the parties to script a conversion as an assets up transaction. No assets are actually transferred and under at least most states law, the entity remains the same, just a different form. This also would be contrary to Rev. Rul. 2004-59, which characterized a conversion as occurring in the same manner as CTB. A tax return preparer that ignores a revenue ruling is potentially subject to a penalty under Code Sec. 6694 for recklessly or intentionally disregarding such revenue ruling unless the preparer meets the substantial authority standard or provides disclosure and it is not a reportable transaction. 53 With the lack of separate entities and the transfer of assets and liabilities, it is doubtful that Rev. Rul. 84-111 applies to support the proposition that an assets up transaction can be successfully scripted. This is particularly true since Rev. Rul. 2004-59 clearly states that Rev. Rul. 84-111 does not apply. LLC Electing Under the Regulations to be Classified as an Association Taxable as a Corporation If the desire is to retain the unincorporated business form but to be an association taxable as a corporation, the LLC may merely follow the procedures outlined in Reg. 301.7701-3(g)(1)(i) and CTB to be so treated. This is accomplished by the filing of Form 8832 with an effective date of not more than 75 days before the filing of the election nor more than one year from the date of filing. 54 Pursuant to the regulations, the assets over analysis applies. Ignoring this regulation would invite preparer penalties under Code Sec. 6694(b) of the greater of $5,000 or 50 percent of the fee. Conclusion As discussed above, from a tax perspective there is a substantive and potentially important difference between the assets over and assets up variations of moving from a partnership to a corporation if one or more members has a substantially different outside basis than the LLC has for an inside basis. If the transaction is classified as an assets over transaction, the corporation will have the basis of the assets in the hands of the corporation with adjustments. If the transaction is classified as an assets up transaction, the corporation will have the basis of the assets in the hands of the members with adjustments. ts. In many instances, the inside and outside basis will be sufficiently close so that any difference eisimm immaterial. ial In such cases either CTB or a conversion may be the simplest and permit (1) the state law form preferred, and (2) the corporate tax treatment desired. In other instances the difference may be material and using the appropriate mechanism is important. Th e longhand method requires the actual transfer of the assets and liabilities that may expose the members who otherwise avoided personal liability, be very difficult to implement, require numerous consents, incur transfer taxes, and perhaps trigger additional gain if some member contributed appreciated property within the past seven years. In lieu of the longhand transfers, if the inside basis is desired, the LLC may CTB, convert or do a formless merger. If the outside basis of the membership interest is desired, the members may transfer their membership interests or if necessary, perhaps attempt to script a formless merger. Some of the methods mean the corporation will have a new federal tax identification number and others will result in the corporation retaining the LLC s federal tax identification number. In some situations the retention of the federal identification numbers can be AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 31

PASSTHROUGH PARTNER critical and in others, almost irrelevant. These shorthand forms of transactions require review of the relevant documents to ascertain what consents and approvals must be obtained. Appropriate documentation must be developed to implement the transaction and establish the desired governance and duties. Finally, the appropriate method must be selected and used. Although not discussed in this column, the state tax ramifications of the different alternatives to achieve the desired result should be analyzed. To the maximum extent possible, all participants should understand the tax and business consequences of the transaction before implementation. APPENDIX I STATUTORY INTERSPECIES MERGERS OF CORPORATIONS AND LLCS GOVERNING LAW IN 50 STATES AND THE DISTRICT OF COLUMBIA State Does the Corporate Statute Permit Conversion? Corporate Statute Does the LLC Statute Permit Conversion? LLC Statute Alabama Yes ALA. CODE 10A-1-8.02 Yes ALA. CODE 10A-1-8.02 Alaska No No Arizona Yes ARIZ. REV. STAT. ANN. 10-1108 Yes ARIZ. REV. STAT. ANN. 29-752 Arkansas Yes ARK. CODE ANN. 47-27-1106 Yes ARK. CODE ANN. 47-32-1206 California Yes CAL. CORP. CODE 1113 Yes CAL. CORP. CODE 17710.11 Colorado Yes COLO. REV. STAT. 7-90-203 Yes COLO. REV. STAT. 7-90-203 Connecticut Yes CONN. GEN. STAT. 34-611 Yes CONN. GEN. STAT. 34-611 Delawareare Yes DEL. CODE ANN. tit. 8 264 Yes DEL. CODE ANN. tit. 6 18-209 District of Columbia Yes D.C. CODE 29-202.01 Yes D.C. CODE 29-202.01 Florida Yes FLA. STAT. 607.1108 Yes FLA. STAT. 605.1021 Georgia Yes GA. CODE ANN. 14-2-1109 Yes GA. CODE ANN. 14-11-901-901 Hawaii Yes HAW. REV. STAT. 414-311 Yes HAW. REV. STAT. 428-904 Idaho Yes IDAHO CODE ANN. 30-1-1100 & 30-18-201 Yes IDAHO CODE ANN. 30-6-1001 & 30-18-201 Illinois Yes 805 ILL. COMP. STAT. 5/11.39 Yes 805 ILL. COMP. STAT. 180/37-20 Indiana Yes IND. CODE 23-1-40-8 Yes IND. CODE 23-18-7-9 Iowa Yes IOWA CODE 490.1102 Yes IOWA CODE 489.1002 Kansas Yes KAN. STAT. ANN. 17-6701, 17-6713, & 17-78-201 Yes KAN. STAT. ANN. 17-7681 & 17-78- 201 Kentucky Yes KY. REV. STAT. 271B.11-080 Yes KY. REV. STAT. 275.345 Louisiana Yes LA. REV. STAT. ANN. 12:117 Yes LA. REV. STAT. ANN. 12:1357 Maine Yes ME. REV. STAT. tit. 13-C, 1102 Yes ME. REV. STAT. tit. 31, 1641 Maryland Yes MD. CODE ANN., Corps. & Ass ns, 3-102 Yes MD. CODE ANN., Corps. & Ass ns, 4A-701 Massachusetts Yes MASS. GEN. LAWS ch. 156D, 11.02 Yes MASS. GEN. LAWS ch. 156C, 59 Michigan Yes MICH. COMP. LAWS 450.1736 Yes MICH. COMP. LAWS 450.4705a Minnesota Yes MINN. STAT. 302A.601 & 302A.651 Adopted MINN. STAT. 322B.70 ( 322C.1002, effective August 1, 2015) 32 TAXES The Tax Magazine AUGUST 2014

APPENDIX I (CONTINUED) STATUTORY INTERSPECIES MERGERS OF CORPORATIONS AND LLCS GOVERNING LAW IN 50 STATES AND THE DISTRICT OF COLUMBIA State Does the Corporate Statute Permit Conversion? Corporate Statute Does the LLC Statute Permit Conversion? LLC Statute Mississippi Yes MISS. CODE ANN. 79-4-11.02 Yes MISS. CODE ANN. 79-29-221 Missouri No Yes MO. REV. STAT. 347.127 Montana No Yes MONT. CODE ANN. 35-8-1201 Nebraska Yes NEB. REV. STAT. 21-20,128 (adopted MBCA 11.02 to be operative January 1, 2016) Yes NEB. REV. STAT. 21-171 Nevada Yes NEV. REV. STAT. 92A.100 Yes NEV. REV. STAT. 92A.100 New Hampshire Yes N.H. REV. STAT. 293-A:11.02 Yes N.H. REV. STAT. 304-C:155 New Jersey Yes N.J. STAT. ANN. 14A:10-1 Yes N.J. STAT. ANN. 42:2C-74 New Mexico No Yes N.M STAT. ANN. 53-19-62 New York Yes N.Y. CORP. LAW 901 Yes N.Y. LTD. LIAB. CO. LAW 1001 North Carolina Yes N.C. GEN. STAT. 55-11-10 Yes N.C. GEN. STAT. 57D-9-40 North Dakota Yes N.D. CENT. CODE 10-19.1-96 Yes N.D. CENT. CODE 10-32-100 Ohio Yes OHIO REV. CODE ANN. 1701.781 Yes OHIO REV. CODE ANN. 1705.36 & 1705.37 Oklahoma Yes OKLA. STAT. tit. 18, 1090.2 Yes OKLA. STAT. tit. 18, 2054 Oregon Yes OR. REV. STAT. 60.481 Yes OR. REV. STAT. 63.481 Pennsylvania Yes 15 PA. CONS. STAT. T. 1921 Yes 15 PA. CONS. STAT. 8956 Rhode Island Yes R.I. GEN. LAWS ANN. 7-1.2-1006 Yes R.I. GEN. LAWS ANN. 7-16-59 South Carolina Yes S.C. CODE ANN. 33-11-101 Yes S.C. CODE ANN. 33-44-904 (Proposed 33-43-1010) South Dakota Yes S.D. CODIFIED LAWS 47-1A-1102 Yes S.D. CODIFIED LAWS 47-34A-902 Tennessee Yes TENN. CODE ANN. 48-21-102 Yes TENN. CODE ANN. 48-249-702 Texas Yes TEX. BUS. ORGS. CODE ANN. 10.001 & 21.452 Yes TEX. BUS. ORGS. CODE ANN. 10.101 & 101.356 Utah Yes UTAH CODE ANN. 16-10a-1101 Yes UTAH CODE ANN. 48-2c-1407 Vermont No Yes VT. STAT. ANN. tit. 11, 3124 Virginia Yes VA. CODE ANN. 13.1-716 Yes VA. CODE ANN. 13.1-1070 Washington Yes WASH. REV. CODE 23B.11.100 & 110 Yes WASH. REV. CODE 25.15.395 West Virginia Yes W. VA. CODE 31D-11-1102 Yes W. VA. CODE 31B-9-904 Wisconsin Yes WIS. STAT. 180.1101 Yes WIS. STAT. 183.1201 Wyoming Yes WYO. STAT. ANN. 17-16-1102 Yes WYO. STAT. ANN. 17-29-1002 AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 33

PASSTHROUGH PARTNER APPENDIX II STATUTORY CONVERSION OF LLCS TO CORPORATIONS GOVERNING LAW IN 50 STATES AND THE DISTRICT OF COLUMBIA State Does the Corporate Statute Permit Conversion? Corporate Statute Does the LLC Statute Permit Conversion? LLC Statute Alabama Yes ALA. CODE 10A-1-8.01 Yes ALA. CODE 10A-1-8.01 Alaska No No Arizona No No Arkansas Yes ARK. CODE ANN. 4-27-1102 Yes ARK. CODE ANN. 47-32-1202 California Yes CAL. CORP. CODE 1157 Yes CAL. CORP. CODE 17710.02 Colorado Yes COLO. REV. STAT. 7-90-201 Yes COLO. REV. STAT. 7-90-201 Connecticut Yes CONN. GEN. STAT. 34-631 Yes CONN. GEN. STAT. 34-631 Delaware Yes DEL. CODE ANN. tit. 8 265 No District of Columbia Yes D.C. CODE 29-204.01 Yes D.C. CODE 29-204.01 Florida Yes FLA. STAT. 607.1115 Yes FLA. STAT. 605.1041 Georgia Yes GA. CODE ANN. 14-2-1109.2 Yes GA. CODE ANN. 14-11-906 (only to non-ga corporations) Hawaii Yes HAW. REV. STAT. 414-271 Yes HAW. REV. STAT. 428-902.5 Idaho Yes IDAHO CODE ANN. 30-1-1100 & 30-18-401 Illinois i No No Yes IDAHO CODE ANN. 30-6-1001 & 30-18-401 Indiana Yes IND. CODE 23-1-38.5-10 10 Yes IND. CODE 23-18-7-10 Iowa Yes IOWA CODE 490.1111 Yes IOWA CODE 489.1006 Kansas Yes KAN. STAT. ANN. 17-6713 & 17-78-401 Kentucky No No Yes KAN. STAT. ANN. 17-7681&17 17-78-78 401 Louisiana Yes LA. REV. STAT. ANN. 12:1602 Yes LA. REV. STAT. ANN. 12:1602 Maine Yes ME. REV. STAT. tit. 13-C, 952 Yes ME. REV. STAT. tit. 31, 1645 Maryland Yes MD. CODE ANN., Corps. & Ass ns, 3-901 Massachusetts Yes MASS. GEN. LAWS ch. 156D, 9.50 No Yes MD. CODE ANN., Corps. & Ass ns, 4A-1101 Michigan Yes MICH. COMP. LAWS 450.1746 Yes MICH. COMP. LAWS 450.4708 Minnesota Yes MINN. STAT. 302A.681 Adopted MINN. STAT. 322C.1007 (effective August 1, 2015) Mississippi No No Missouri Yes MO. REV. STAT. 351.408 No Montana No No Nebraska Adopted (not numbered) Adopted MBCA 9.50 authorizing such conversion. 2014 Nebraska Laws L.B. 749 to be operative January 1, 2016 Yes NEB. REV. STAT. 21-175 34 TAXES The Tax Magazine AUGUST 2014

APPENDIX II (CONTINUED) STATUTORY CONVERSION OF LLCS TO CORPORATIONS GOVERNING LAW IN 50 STATES AND THE DISTRICT OF COLUMBIA State Does the Corporate Statute Permit Conversion? Corporate Statute Does the LLC Statute Permit Conversion? LLC Statute Nevada Yes NEV. REV. STAT. 92A.105 Yes NEV. REV. STAT. 92A.105 New Hampshire Yes N.H. REV. STAT. 293-A:9.50 No New Jersey No Yes N.J. STAT. ANN. 42:2C-74 New Mexico No Yes N.M STAT. ANN. 53-19-60.1 New York No No North Carolina Yes N.C. GEN. STAT. 55-11A-01 Yes N.C. GEN. STAT. 57D-9-30 North Dakota Yes N.D. CENT. CODE 10-19.1-104.1 Yes N.D. CENT. CODE 10-32-108.1 Ohio Yes OHIO REV. CODE ANN. 1701.782 Yes OHIO REV. CODE ANN. 1705.371 Oklahoma Yes OKLA. STAT. tit. 18, 1090.4 Yes OKLA. STAT. tit. 18, 2054.2 Oregon Yes OR. REV. STAT. 60.472 Yes OR. REV. STAT. 63.470 Pennsylvania No No Rhode Island Yes R.I. GEN. LAWS ANN. 7-1.2-1007 Yes R.I. GEN. LAWS ANN. 7-16-5.2 South Carolina No Yes S.C. CODE ANN. 33-44-908 (Proposed 33-43-1004) South Dakota a Yes S.D. CODIFIED LAWS 47-1A-950.2 & 950.3 Yes S.D. CODIFIED LAWS 47-34A-906 Tennessee ee Yes TENN. CODE ANN. 48-21-109 Yes TENN. CODE ANN. 48-249-704 Texas Yes TEX. BUS. ORGS. CODE ANN. 10.101 & 21.453 Yes TEX. BUS. ORGS. CODE ANN. 10.101 & 101.356 Utah Yes UTAH CODE ANN. 16-10a-1008.7 Yes UTAH CODE ANN. 48-2c-1406 Vermont No No Virginia Yes VA. CODE ANN. 13.1-722.9 Yes VA. CODE ANN. 13.1-1010.4 Washington No No West Virginia No No Wisconsin Yes WIS. STAT. 180.1161 Yes WIS. STAT. 183.1207 Wyoming Yes WYO. STAT. ANN. 17-26-101 Yes WYO. STAT. ANN. 17-26-101 ENDNOTES 1 Code Secs. 704(c)(1)(B) and 737. 2 Reg. 1.704-4(c)(5) and 1.737-2(c). 3 While this column will discuss LLCs, the principles are generally applicable to all forms of partnerships (general partnerships, limited partnerships, limited liability partnerships and limited liability limited partnerships). While the state law characteristics will vary significantly among these different forms, for federal tax purposes, they are all partnerships. 4 Going from a corporation to a partnership almost always triggers a taxable gain and/or causes the forfeiture of loss carryforwards or future carrybacks. 5 Unless indicated to the contrary, the term LLC means a domestic limited liability company that has not elected to be taxed as an association taxable as a corporation. 6 There is no personal state income tax in AK, FL, NV, NH, SD, TN, TX, WA or WY. There is no tax on LLC, LP, LLP or GP income in FL, NV, SD AUGUST 2014 2014 CCH INCORPORATED. ALL RIGHTS RESERVED. 35

PASSTHROUGH PARTNER or WY. AK and NH both tax income from any business (regardless of its federal tax status) at each state s corporate tax rate. See Alaska Stat. Ann. 43.20.040; N.H. Rev. Stat. Ann. 77-A:2 (2013). Tennessee taxes income of LLCs, LPs and LLPs at its state corporate tax rates. Tennessee does not apply any state income tax to GPs. See Tenn. Code Ann. 67-2-104. Texas applies a margin tax on LLCs, LPs and LLPs unless they qualify as passive entities. See Tex. Code Ann. 171.001; Tex. Code Ann. 171.0002. Washington applies a business and occupation tax to all persons and entities conducting business having a substantial nexus with the state. See Wash. Rev. Code 82.04.220 (2011). 7 The actual quote used a slightly different word starting with a da and ending with an n. 8 The order of transactions is that found in Rev. Rul. 84-111 in describing the tax treatment of each of these variations of incorporation of a partnership. Each pattern is referred to as a situation. 9 1984-2 CB 88. 10 If the corporation elects S corporation status, the liquidation of the LLC must be part of the prearranged plan and must happen promptly for the LLC to be ignored for purposes of determining eligible shareholders. A period of time as a C corporation before the S election will trigger the future application of the built in gains tax in the event assets are disposed within the relevant period (presently 10 years). See Code Sec. 1374(d)(7). 11 Generally ly the LLC statutes do not require the consent of all members, but one should verify what the operative e statute and documents require. 12 See Del. Code Ann. tit. 6, 18-801 (default rule of a super majority vote or consent). nt). 13 See eetenn. n. Code Ann. 48-249-605 (default rule of a majority in interest). 14 The assets over is the rule for conversions and CTB. 15 1970-1 CB 74. 16 It should be noted that GCM 37540 (May 18, 1978) provided the analysis and concluded that Rev. Rul. 70-239 should be modified in the form finally occurring in Rev. Rul. 84-111. The lengthy delay may underscore the preference for the Treasury and the IRS to the assets over approach. 17 See Code Secs. 704(c)(1)(B) and 737. The exception for deemed transfers of Code Sec. 704(c) property found in Reg. 1.737-2(c) does not apply to an actual transfer of the assets in implementing a Code Sec. 351 transaction. 18 Reg. 1.737-2(c). 19 Code Sec. 708(b)(1)(A). 20 Code Secs. 741 and 751. 21 So long as the transferring members have at least 80 percent of vote and value of the corporation, they will not be subject to tax. The test is at the corporate level, not the partnership level. 22 It is possible that the corporation had not obtained the requisite consent to become a member on the theory that it would become the only member. The transferring members may find themselves the shareholder of a corporation holding a mere financial right and no governance rights. 23 McCauslen, 45 TC 588, Dec. 27,889 (1966). Rev. Rul. 99-6 cites McCauslen and Rev. Rul. 67-65. 24 1967-1 CB 168. 25 1999-1 CB 432. 26 1980-2 CB 124. 27 1984-2 CB 88. 28 Rev. Rul. 84-111 assumes partnership debt is less than the adjusted basis of the partnership s assets and does not discuss any debt associated with the membership interest itself. 29 Id. 30 Code Sec. 351(a) via cross-reference to Code Sec. 368(c). 31 Code Secs. 752(b) and 733. 32 Reg. 1(h)-1. The nature of the underlying assets is also relevant if they include installment notes [ Rev. Rul. 60-352 ] or investment credit property [Reg. 1.47-6(a)(2)]. 33 Code Sec. 358(a) and (d). The starting basis is adjusted under Code Sec. 705 for the deemed ed distribution ib tion of money and any gain recognized. ed 34 Code Sec. 1223(1). 35 William S. Mckee, William F. Nelson, Robert L. Whitmire, et. al., FED TAX N NOF PARTNERSHIPS AND PARTNERS, at 18.03[10] (3d ed. 1997 & 2010 Supp., No. 3). 36 Code Sec. 705. The basis is allocated among the assets in accordance with Code Sec. 732(c). 37 Code Sec. 732(b). 38 As discussed previously from the analysis pertaining to the transferring member and controlling the tax ramifications to the transferring member, the transferring member s gain is triggered but not as a result of the corporate analysis. 39 Code Sec. 735(b). 40 Id. 41 This basis is determined after reflecting the income, gain and loss for the tax year ending on the date of the deemed liquidation of the corporation and then making the adjustments discussed herein. 42 Code Sec. 362(a). 43 Code Sec. 1223(2). 44 See Del. Code Ann. tit. 6 18-216 (Delaware default rule is approval of members with over 50 percent (in interest). 45 Id. 46 LTR 9409035 (Dec. 7, 1993). This dealt with the merger of a publicly traded limited partnership into a trust subsidiary receiving shares of the trust. The trust was to elect REIT status. 47 Id. 48 See e.g., Del. Code Ann. tit. 6 18-301(h) The rights, privileges, powers and interests in property of the limited liability company that was converted, as well as the debts, liabilities and duties of such limited liability company, shall not be deemed, as a consequence of the conversion, to have been transferred to the other entity or business form to which limited liability company has converted for any purpose of the laws of the State of Delaware. T.C.A. 248-249- 704(h)(i) The converted other entity shall be deemed to be the same entity as the domestic LLC. 49 See Code Secs. 1361 1379 (S corporation requirements). 50 2000-2 CB 593. 51 Id. 52 Reg. 301.7701-3(g)(1)(i). 53 Reg. 1.6694-3(c)(3). 54 Reg. 301.7701-3(c)(1)(iii) requires the filing of Form 8832. It is effective on the date filed or the date specified on the form, which cannot be more than 75 days prior to the filing or more than one year after the date of the filing. However, for newly formed entities ie that wish to elect out of the default classification, Rev. Proc. 2002-15 permits a filing within six months and 75 days of the entity s formation if (1) the entity failed to obtain the desired classification as of the date of formation by failure to file the Form 8832, (2) the due date for the initial income tax return for the entity has not passed, and (3) the entity had reasonable cause for failure to make the timely election. In Rev. Proc. 2009-41, the IRS extended late classification relief to both initial classification and classification change to within three years and 75 days of the requested effective date of the eligible entity s classification. This article is reprinted with the publisher s permission from the TAXES The Tax Magazine, a month ly journal published by CCH, a part of Wolters Kluwer. Copying or dis tri bu tion without the pub lish er s per mis sion is prohibited. To subscribe to the TAXES The Tax Magazine or other CCH Journals please call 800 449 8114 or visit CCHGroup.com. All views expressed in the articles and col umns are those of the author and not necessarily those of CCH. 36 TAXES The Tax Magazine AUGUST 2014