Question

Turnaround LLC was formed several years ago. It incurred losses for several years, reducing many of its members’ bases in their interests to zero. However, the business has recently obtained some new and promising contracts, anticipating profits in the coming years if it can obtain some financing. It admitted new members who each made capital contributions for their interests. The owners anticipate it will be necessary to reinvest most of the profits back into the business for some time. As there will no longer be losses to pass through, and the double taxation of profits will be delayed for some time, the owners of Turnaround are considering converting the business to a C corporation. The business has the following assets (assume there is no § 754 election in effect): 527-L-B-L-B-A%20(486).png The original owners of Turnaround, who now have a 50% capital and profits interest, have come to you for advice regarding the potential tax consequences of the conversion for them as well as for the new corporation. Partial list of research aids: Rev.Rul. 70–239. Rev.Rul. 84–111. Rev.Rul. 2004–59. Treas. Reg. § 301.7701–3(g)(i).

Answer 1

Under Federal tax law, when a LLC elects to convert into corporation, it has to file a return as soon as the LLC stop to exist and pay all the due taxes.

There are three different ways of converting LLC to C corporation

1. Asset over - In this method, The LLC transfers all its assets and liabilities to the corporation in exchange of outstanding stock of the corporation and then LLC distribute all the stock to the member by terminating itself.

2. Asset up - LLC distribute all its assets and liabilities to its member to terminate the LLC. and then members transfer the assets and liabilities to the corporation in exchange of outstanding stock of the corporation.

3. Interests over - The LLC members transfers their interest in LLC to the corporation in exchange of outstanding stock of the corporation which terminates the LLC. and all the assets and liabilities of the LLC becomes the assets and liabilities of the corporation.

Under section 301-7701-3(g)(i) it is provided that if the LLP elects to converts as C corporation, it is deemed that the first method (asset over) is used to convert LLC in a corporation.

Revenue Rul. 84-111 describes the differences in the basis and holding period of the various assets received by the corporation and the basis and holding period of stock received by all the members.

Whatever method is used to transfer LLC assets and liabilities to corporation in exchange of outstanding stock of the corporation, tax consequences are same. These transfer come under section 351, where no gain or loss is recognized if property is transfered in exchange of shares, and immeditely after that transfer, transferee/transferees are in control of the corporation.

In this case, the original owners of Turnaround have 50% interest in corporation, thus we can say they are in control of the corpoartion and neither they nor the corporation can recognize any gain or loss in this conversion.