We often preach about converting existing corporations to limited liability companies, both for tax and non-tax reasons. If the conversion is effected for tax planning reasons, it generally results in a liquidation of the corporation and the contribution of the corporate assets to a limited liability company taxed as either a disregarded entity or a partnership.
The liquidation of the corporation, for tax purposes, can carry very significant tax consequences, and must be carefully planned. While the tax structures used to convert a corporation into an LLC are complex and beyond the scope of this newsletter, they include (i) the so-called "parallel operation," (ii) a parallel operation with a sale of assets, (iii) a parallel operation combined with leasing of assets, (iv) a joint venture, (v) a joint venture with a freeze, and (vi) an installment sale.
If the conversion is effected for a non-tax purpose, such as to gain the charging order protection afforded by LLCs, then it is possible to structure the conversion so that it will have absolutely no tax consequences. It is accomplished in the following manner.
First, Form LLC-1A needs to be filed with the California Secretary of State. Form LLC-1A is a simple pre-printed form that requires you to fill in the name of the new LLC and the name of the old corporation. Once the form is filed and accepted, the conversion takes place and all the assets and liabilities of the old corporation automatically move over to the new LLC.
Second, Form 8832, Entity Classification Election, must be filed with the Internal Revenue Service. On this form you need to elect to tax the newly formed LLC as a corporation. When filing this form, continue using the EIN of the old corporation. (See Rev. Rul. 73-526 for authority to keep the old EIN.)
Third, on the tax return of the corporation, disclose to the IRS that the corporation went through an F reorganization. This will insure that there are no tax consequences as a result of the conversion. There are numerous PLRs and FSAs supporting the proposition that a conversion of a corporation to an LLC under state law is an F reorganization. (For example, PLR 200528021.)
Fourth, if the corporation was an S corporation, the S election survives the conversion and the election will continue to apply the corporation that is now an LLC under state law. (See Rev. Rul. 64-250.)
The end result is that for tax purposes, nothing happened to your old corporation. It simply went through an F reorganization, allowing the corporation to keep its EIN, tax year and all tax attributes. However, under state law we now have an LLC, with all the resulting liability protection afforded to LLCs, including the charging order protection for LLC interests.
We commonly use this structure for clients who own valuable stock in closely-held corporations when they are facing a judgment. Simply contributing the stock of the corporation to an LLC at that point may be challenged as a fraudulent transfer, and the conversion becomes an attractive alternative.
Don't Forget to Tell Your Clients:
On November 10 (at 10 am) and on November 28 (at 6 pm) we will be offering a free seminar for real estate investors and developers focusing on advanced asset protection and tax planning issues. Your clients are welcome to attend, but the need to RSVP by calling us at (818) 598-2252.