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Discussion:LLC taxed as partnership conversion to S-Corp

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Discussion Forum Index --> Advanced Tax Questions --> LLC taxed as partnership conversion to S-Corp


Discussion Forum Index --> Tax Questions --> LLC taxed as partnership conversion to S-Corp

Porterj5 (talk|edits) said:

12 March 2014
Client is currently a multi-member LLC in NC and is taxed as a partnership. Partners are both individuals. Partner A owns 95% and Partner B owns 5%. They are wanting to convert to an S-corp starting 2014 (timely as long as filed by March 15th). At the end of 2013 the balance sheet is made up of the following items:


Cash 2,000

Depreciable assets 1,300

Accum. Depr. (1,000)

Total Assets 2,300


Liabilities

Credit Card 90

Loan from partner B 1,000


Equity

Partner A Capital 1,089

Partner B Capital 121

Total Equity and Liab 2,300


When they elect to be taxed as a corporation and then tax as an S-Corp do they need to create a new LLC or would the original LLC stay in place and simply be taxed differently going forward?

Would any gain be recognized on conversion?

If I am reading Rev Rul 84-111 correctly it would seem that there would be no gain and that both partners would have stock basis equal to their capital accounts and that Partner B would have loan basis of $1,000.

If any additional information is required please let me know.

Ckenefick (talk|edits) said:

12 March 2014
You can just file the 2553, which is a dual election in this case: taxed as a corp, then taxed as an S.

Porterj5 (talk|edits) said:

12 March 2014
Ok. Am I correct that there should be no gain by making the election? Also, would they need to get a new EIN? They have already started taking reasonable compensation payroll and sending in tax payments under the current EIN.

Marcilio (talk|edits) said:

12 March 2014
No changes. They are simply electing the option to be taxed as an S corporation. The company would still exist as an LLC, but filing an 1120S instead of a 1065.

JR1 (talk|edits) said:

March 12, 2014
Your only issue is that you must follow S corp law in terms of profit distribution, which must be in ownership % allocation only. (You can balance between them with salaries, of course.) So I'd wonder about the loan from B and if 351 requires that to become capital, which then maybe makes an imbalance in equity? Just asking, don't know....

Ckenefick (talk|edits) said:

12 March 2014
It can stay as debt. Shouldn't be any 357c issues since we're not upside down on the equity, on a tax basis.

Doug M (talk|edits) said:

12 March 2014
If it stays as debt, then you have taxable income under IRC 351

Section 1.351-2 Receipt of property.

(a) If an exchange would be within the provisions of section 351(a) if it were not for the fact that the property received in exchange consists not only of property permitted by such subsection to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. No loss to the recipient shall be recognized.

Bushmaster (talk|edits) said:

12 March 2014
I have a couple LLCs done this way, but with multi members. Any issue with a single member LLC electing S Corp status?

Ckenefick (talk|edits) said:

12 March 2014
See Sec 357(a), which says that the debt relief isn't treated as "other property or money" (i.e. boot).

Southparkcpa (talk|edits) said:

12 March 2014
Agree with all the above. Problems arise when we have negative partner cap accts (equity), generally speaking.

Harry Boscoe (talk|edits) said:

12 March 2014
The LLC has to send in a completed Form 2553 by Monday next, the 17th of March. I *think* it gets to keep its old EIN. I suspect that Rev Rul 84-111 applies, even though it - the Rev Rul - predates all the LLC and Section 7701 "check the box" stuff by many years. As noted above, the Form 2553 that needs to be submitted by Monday functions in two fashions all at the same time: it allows the LLC to elect to be treated as an association taxed as a corporation, and it allows the LLC-electing-to-be-taxed-as-a-corporation to make the statutory election to be taxed as an S corporation.

Ckenefick (talk|edits) said:

12 March 2014
http://www.reuters.com/article/2013/05/31/us-usa-tax-checkthebox-insight-idUSBRE94T17K20130531

Harry Boscoe (talk|edits) said:

12 March 2014
I wrote, above, that the dual election can be made by Monday the 17th, but now I can't find anything that says that it's okay on Monday the 17th and I'm getting tired of looking. Does anybody know that the 2553-and-8832 election mailed on Monday the 17th can be a *timely* election for the 2014 calendar year?

"Saturday, Sunday, or legal holiday..." is the type of language that I'm looking for; in a regulation, ruling, publication, instruction, just about *anywhere*, would make me happy.

JR1 (talk|edits) said:

March 12, 2014
Why wait?

Nilodop (talk|edits) said:

13 March 2014
IRM 3.13.2.22.3 (01-01-2014)

Timeliness of an Election

A taxpayer is timely with their S election if their Form 2553 is received before the 16th day of the third month of their tax year. If the due date falls on a weekend or holiday, the due date becomes the next business day. http://www.irs.gov/irm/part3/irm_03-013-002r-cont04.html#d0e18423

Nilodop (talk|edits) said:

13 March 2014
In an actual 351 transfer (as distinguished from the LLC situation where no actual corporation is formed), this info is required: http://www.law.cornell.edu/cfr/text/26/1.351-3. I don't know for sure, but isn't it also required here? (But not right away).

Ckenefick (talk|edits) said:

13 March 2014
Yeah, by the partnership.

Nilodop (talk|edits) said:

13 March 2014
http://www.irs.gov/pub/irs-pdf/p509.pdf is a tax calendar and it says: March 17 … S corporation election. File Form 2553, Election by a Small Business Corporation, to elect to be treated as an S corporation beginning with calendar year 2014.

It also says: Saturday, Sunday, or legal holiday. Generally, if a due date for performing any act for tax purposes falls on a Saturday, Sunday, or legal holiday, the act is considered to be performed timely if it is performed no later than the next day that is not a Saturday, Sunday, or legal holiday.

You said you'd accept anything, right? Try Sec 7503 and Reg. 301.7503-1.

Doug M (talk|edits) said:

13 March 2014
Disagree about the applicability of 357(a).

IRC 351 says solely in exchange for stock.

This is exchange for stock and $1,000 in cash, to be paid at a future date to a transferring partner.

Ckenefick (talk|edits) said:

13 March 2014
357 is at play b/c we're dealing with debt assumption.

Cash to be paid in the future would be, in this case, a Receivable, which is already held by the partner.

If this is cast as a partnership distribution and then a corporate contribution, the receivable isn't being received in addition to the stock, the partner (now shareholder) has always held the Receivable. All that's changed is the payer. The corp is merely assuming the obligation. The corp does not have an asset that is being distributed out on the 351 event.

If it's cast as a partnership contribution to the corporation, again, the partner already holds the receivable. All the partnership gets is stock, which it then distributes out to the partners.

Doug M (talk|edits) said:

13 March 2014
Yes, the corp. is assuming an obligation. But, the transferor is receiving stock and boot. Taxable.

Ckenefick (talk|edits) said:

13 March 2014
IRC 351 says solely in exchange for stock.

If that's really how it worked, then there'd be no need for 357, seeing that every debt assumption would be taxable under 351.

From 357(a):

then such assumption shall not be treated as money or other property, and shall not prevent the exchange from being within the provisions of section 351 or 361, as the case may be.

Nilodop (talk|edits) said:

13 March 2014
100% agree with Ck on this one. If not correct, there would almost never be a tax-free (more technically accurate, a tax-deferred) incorporation of a partnership.

Ckenefick (talk|edits) said:

13 March 2014
Yeah, if you think about it, when an individual makes a 351 contribution, any obligation assumed by the corp be viewed as boot even when the creditor isn't the individual contributor. If I have a building with a bank loan attached to it, and the corp assumes the loan, this could work fine under 351 assuming I'm not upside down per 357(a). But, what if I'm afraid the lender will call the loan if the lender sees a corporation making the monthly payments...so, instead of having the corp "assume" the bank debt, I simply cast the loan that the corp will pay as a personal one. That is, corp will write checks to me and I will then write personal checks to the bank/lender. Don't think the tax result should be any different, even though I now have a "receivable" from the corporation.

Now, where the Code has a problem with assumed debt is when there's no bona fide business reason for doing it, like if I slap a debt on an unencumbered piece of property right before contributing it and extract $x in cash...and then the corp assumes the "new" loan. In that case, transaction could be cast as no corp debt assumption, then as if corp took out a loan for $x, and then corp is deemed to have distributed the $x in cash to me as boot. This is what 357(b) is after. There is very similar stuff in the partnership context when you have what seems to be (or might be) a disguised sale involving debt relief. In that case, you look at every single liability to see if it is "qualified" or not. You also see this in the 1031 area.

Harry Boscoe (talk|edits) said:

15 March 2014
Len - Thanks for the cite to - and the quote from - the IRM. Why do I never even think of the IRM as a source for things like this? Do you have a road map or some special way of accessing it? I've always found it bafflingly cumbersome to work with...

And while I'm whining, try this on: The IRM tells us when the 2553 has to be *received* to be timely. That's not a hard call, is it? *Received* before the 16th day of the third month says nothing about *mailing* or *filing* and seems sort of a limp description of what's required.

Ckenefick (talk|edits) said:

15 March 2014
Do you have a road map or some special way of accessing it?

Depends which section you want. If I want the beginning, I go to the wall near the front door in my office, where the IRM begins. I wall-papered it up many years ago, in a clockwise fashion around the office. I hope it hasn't changed much. Yes, some clients think it's a little "weirdy," as one gal put it, so her return will reflect a little extra *phantom* income this year. Who is weirdy now, I ask? The guy with the IRM wallpaper in his office, or the woman who pays tax on non-existent income?

Nilodop (talk|edits) said:

15 March 2014
Harry, I also cited Code and Reg.

As to IRM, no secret - just routine search process.

I did notice "received" in the Manual, but, as is not unusual, that is simply careless writing - something I do all too often. See Sec 7502.

Ck, I guess you showed her! A bit like what some of us did in the Army Finance Corps back in the day. If some soldier pissed us off, we shipped their pay card to Korea. (It was an actual card, 8-1/2 x 11, filled in manually by us powerful guys in the Finance Corps).

Markb29 (talk|edits) said:

15 March 2014
Len - Thanks for the cite to - and the quote from - the IRM. Why do I never even think of the IRM as a source for things like this? Do you have a road map or some special way of accessing it? I've always found it bafflingly cumbersome to work with...

that's hilarious - I started my career as a revenue agent at IRS - couldn't figure out the damn thing then or now - organized like it was put together randomly. It was my first clue how screwed up the government was(is).

Spell Czech (talk|edits) said:

15 March 2014
Yeah, whatever, Len, but you didn't cite anything that might explain how the "not more than 75 days earlier" rule found in the regs under Section 7701 would work in a leap year wherein March 15th falls on Saturday...

The "due date" [please notice the vicious quotation marks there] for the "check-the-box-for-elective-classification-of-entity-type" - i.e., the Form 8832 function - is another story, I think. Seventy-five days before Monday, March 17th, in *that* year, would be January 2nd, not the 1st, I think. Only our gummint could get this so balled up.

Mark: Right on, Dude, you've known this longer than some of us have been alive.

Markb29 (talk|edits) said:

15 March 2014
Mark: Right on, Dude, you've known this longer than some of us have been alive.


this makes me feel good , how ?

Nilodop (talk|edits) said:

18 March 2014
Spell, since 2014 is not a leap year, I am free of guilt in waiting until now before looking at your implied question above Yeah, whatever, Len, but you didn't cite anything that might explain how the "not more than 75 days earlier" rule found in the regs under Section 7701 would work in a leap year wherein March 15th falls on Saturday…

If I'm understanding the issue, it's only a problem for a Form 8832 election where there is no desire to be taxed as an S corporation. No Form 8832 is required (or, I think, even allowed) to be used if, along with electing to be treated as an "association" taxed as a corporation, the entity also elects to be treated as an S corporation. Instead, a Form 2553 is required, and, as you know, it serves the dual purposes of electing both corporate treatment and S corporation treatment. And neither the 1362 reg. nor the Form 2553 has a 75-day requirement like the one for Form 8832, which in turn comes from the 7701 reg.

So, again if I'm understanding the issue, the 75-day rule on Form 8832 [and in Reg. 301.7701-3(c)(iii)] is only an issue where the eligible (unincorporated) entity wants to elect C corporation treatment using Form 8832. And there, yes, there is a problem. There would seem to be no availability of the 7503 Sat./Sun./holiday rule.

And, if I didn't already say so, that's if I'm understanding the issue.

Spell Czech (talk|edits) said:

21 March 2014
Actually, what I was trying to say was that a Section 7701 check-the-box election to be treated as an association and taxed as a corporation that's made on Monday, March 17th, of a leap year, isn't going to be effective as of January 1st, whether or not there's an election to be taxed as an S corporation being made at the same time. The 7701 election timing regs are still in play, aren't they?

Nilodop (talk|edits) said:

21 March 2014
That's what I was afraid you were "trying to say". And it is what you did say.

I'm trying to understand what this, from Reg. 301.7701-3(c)(1)(v) means: "(C) S corporations. An eligible entity that timely elects to be an S corporation under section 1362(a)(1) is treated as having made an election under this section to be classified as an association, provided that (as of the effective date of the election under section 1362(a)(1)) the entity meets all other requirements to qualify as a small business corporation under section 1361(b). Subject to § 301.7701-3(c)(1)(iv), the deemed election to be classified as an association will apply as of the effective date of the S corporation election and will remain in effect until the entity makes a valid election, under § 301.7701-3(c)(1)(i), to be classified as other than an association."

And this, from the 2553 Instructions: "General Instructions Purpose of Form A corporation or other entity eligible to elect to be treated as a corporation must use Form 2553 to make an election under section 1362(a) to be an S corporation. An entity eligible to elect to be treated as a corporation that meets certain tests discussed below will be treated as a corporation as of the effective date of the S corporation election and does not need to file Form 8832, Entity Classification Election."

And this, from the 8832 Instructions: "Do not file this form for an eligible entity that is: … • Electing to be classified as an S corporation. An eligible entity that timely files Form 2553 to elect classification as an S corporation and meets all other requirements to qualify as an S corporation is deemed to have made an election under Regulations section 301.7701-3(c)(v) to be classified as an association taxable as a corporation."

And yes, I see both interpretations as possible, because of the reference to 301.7701-3.

Ckenefick (talk|edits) said:

3 April 2014
So, what's the deal? If we have a leap year and 3/15 is a Saturday and we want an effective date of 1/1 and we file the 8332 on 3/17, the effective date won't be 1/1...is that what you're saying? It will instead be 1/2?

Nilodop (talk|edits) said:

3 April 2014
That's what he is saying, but I think that might be overridden by filing the 2553.

Ckenefick (talk|edits) said:

3 April 2014
I was gonna get to that next...what if the 2553 is filed before the entity is granted corporate status?

But if all the timing works out (i.e. you file the 8832 on 2/15, then file the 2553 on 3/1), that would for sure be valid effective 1/1. If you file both on 3/17...then what????

Nilodop (talk|edits) said:

3 April 2014
Yes, "then what?" is the question. We know the question. And you don't file "both". They tell you not to file an 8832 if you want S status. Just file the 2553.

Ckenefick (talk|edits) said:

3 April 2014
And you don't file "both".

Actually, you can do it either way.

Nilodop (talk|edits) said:

3 April 2014
OK. But what if you don't file the 8832. You file the 2553 on 3/17 of a leap year in which 3/15 is on a Saturday.

Ckenefick (talk|edits) said:

3 April 2014
Below is what you wrote above. Seems pretty obvious to me that they go by the effective date on the 2553.

S corporations. An eligible entity that timely elects to be an S corporation under section 1362(a)(1) is treated as having made an election under this section to be classified as an association, provided that (as of the effective date of the election under section 1362(a)(1)) the entity meets all other requirements to qualify as a small business corporation under section 1361(b). Subject to § 301.7701-3(c)(1)(iv), the deemed election to be classified as an association will apply as of the effective date of the S corporation election and will remain in effect until the entity makes a valid election, under §301.7701-3(c)(1)(i), to be classified as other than an association.

Nilodop (talk|edits) said:

3 April 2014
That's how i see it. But Spell points out the conflict with (iii) of the reg.: The effective date specified on Form 8832 can not be more than 75 days prior to the date on which the election is filed and can not be more than 12 months after the date on which the election is filed. If an election specifies an effective date more than 75 days prior to the date on which the election is filed, it will be effective 75 days prior to the date it was filed.

Ckenefick (talk|edits) said:

3 April 2014
Didn't you just say, "But what if you don't file the 8832."

Nilodop (talk|edits) said:

3 April 2014
Yes.

Nilodop (talk|edits) said:

3 April 2014
And Spell said above Actually, what I was trying to say was that a Section 7701 check-the-box election to be treated as an association and taxed as a corporation that's made on Monday, March 17th, of a leap year, isn't going to be effective as of January 1st, whether or not there's an election to be taxed as an S corporation being made at the same time. The 7701 election timing regs are still in play, aren't they? Spell, where are you?

Ckenefick (talk|edits) said:

3 April 2014
Yeah, I get that. But you said "But what if you don't file the 8832." If you don't file the 8832, then I can stop reading when you wrote, "The effective date specified on Form 8832..."

Now, if you want to go back to the scenario where we separately file the 8832 and the 2553 - perhaps even on the same day - 3/17 - just let us know...but you may very well have a problem, but it's not real different than the old problem when the entity you're making an s-election for isn't a corporation.

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