structuring section 708 partnership mergers absent irs...

Structuring Section 708 Partnership MergersAbsent IRS Guidance: Avoiding Terminationin Collapsing TransactionsAssets-Over vs. Assets-Up Transactions, Maintaining Continuity of Interest, and Deferring Tax Recognition

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WEDNESDAY, SEPTEMBER 28, 2016

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Today’s faculty features:

Joseph K. Fletcher, III, Partner, Glaser Weil Fink Howard Avchen & Shapiro, Los Angeles

Joseph C. Mandarino, Partner, Smith Gambrell & Russell, Atlanta

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FOR LIVE EVENT ONLY

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For CPE credits, attendees must participate until the end of the Q&A session andrespond to five prompts during the program plus a single verification code. In addition,you must confirm your participation by completing and submitting an AttendanceAffirmation/Evaluation after the webinar and include the final verification code on theAffirmation of Attendance portion of the form.

For additional information about continuing education, call us at 1-800-926-7926 ext.35.

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In order for us to process your continuing education credit, you must confirm yourparticipation in this webinar by completing and submitting the AttendanceAffirmation/Evaluation after the webinar.

A link to the Attendance Affirmation/Evaluation will be in the thank you email that youwill receive immediately following the program.

For CPE credits, attendees must participate until the end of the Q&A session andrespond to five prompts during the program plus a single verification code. In addition,you must confirm your participation by completing and submitting an AttendanceAffirmation/Evaluation after the webinar and include the final verification code on theAffirmation of Attendance portion of the form.

For additional information about continuing education, call us at 1-800-926-7926 ext.35.

Joseph K. Fletcher, IIIPartner, Glaser Weil

[email protected]

©2016 Glaser Weil Fink HowardAvchen & Shapiro LLP 41239526

Entity Mergers and Conversions:Entity Mergers and Conversions:State Laws and Tax LawsState Laws and Tax Laws A merger involves two or more entities.

Interspecies mergers have become common.

A conversion involves only one entityconverting into another type of entity.Interspecies conversions have also becomecommon.


A merger involves two or more entities.Interspecies mergers have become common.

A conversion involves only one entityconverting into another type of entity.Interspecies conversions have also becomecommon.

Entity Mergers and Conversions:Entity Mergers and Conversions:State Laws and Tax LawsState Laws and Tax Laws Prior to the availability of conversions, a

conversion to another business entity type wasgenerally accomplished in two steps:

◦ (1) the new entity was formed (for example, an LLC);

◦ (2) the existing entity was merged into the new entity, with thenew entity surviving.

This two-step merger had actual “steps.”

Today, two-step mergers are still possible, but onestep conversions also exist.


Prior to the availability of conversions, aconversion to another business entity type wasgenerally accomplished in two steps:

◦ (1) the new entity was formed (for example, an LLC);

◦ (2) the existing entity was merged into the new entity, with thenew entity surviving.

This two-step merger had actual “steps.”

Today, two-step mergers are still possible, but onestep conversions also exist.

Ease of Conversion (CA example)Ease of Conversion (CA example) The ease of conversion is illustrated by the CA Secretary of State

website: http://www.sos.ca.gov/business-programs/business-entities/conversion-information/

If the converted entity will be a California LLC: The converting entity must be a California Corp, LP or GP; or Foreign Corp, LLC, LP, GP or

Other Business Entity; File Articles of Organization – Conversion (Form LLC-1A)(PDF - REV 01/2016); and The filing fee is $150 if a California Corp is involved; and $70 for all others. If the converted entity will be a California LP: The converting entity must be a California Corp, LLC or GP; or Foreign Corp, LLC, LP, GP or

Other Business Entity; File a Certificate of Limited Partnership – Conversion (Form LP-1A)(PDF - REV 01/2016); and The filing fee is $150 if a California Corp is involved; and $70 for all others. If the converted entity will be a Registered GP: The converting entity must be a California Corp, LLC or LP; or Foreign Corp, LLC, LP or Other

Business Entity; File a Statement of Partnership Authority – Conversion (Form GP-1A)(PDF - REV 01/2016);

and The filing fee is $150 if a California Corp is involved; and $70 for all others. If the converted entity will be a Non-registering GP: The converting entity must be a California Corp, LLC or LP; or Registered Foreign Corp, LLC,

LP or Other Business Entity; File a Certificate of Conversion (Form CONV-1A)(PDF - REV 01/2016); and The filing fee is $150 if a California Corp is involved; and $30 for all others. If the converted entity will be a Foreign Entity: The converting entity must be a California LLC or LP, or Registered California GP; File a Certificate of Conversion (Form CONV-1A)(PDF - REV 01/2016); and The filing fee is $30.


The ease of conversion is illustrated by the CA Secretary of Statewebsite: http://www.sos.ca.gov/business-programs/business-entities/conversion-information/

If the converted entity will be a California LLC: The converting entity must be a California Corp, LP or GP; or Foreign Corp, LLC, LP, GP or

Other Business Entity; File Articles of Organization – Conversion (Form LLC-1A)(PDF - REV 01/2016); and The filing fee is $150 if a California Corp is involved; and $70 for all others. If the converted entity will be a California LP: The converting entity must be a California Corp, LLC or GP; or Foreign Corp, LLC, LP, GP or

Other Business Entity; File a Certificate of Limited Partnership – Conversion (Form LP-1A)(PDF - REV 01/2016); and The filing fee is $150 if a California Corp is involved; and $70 for all others. If the converted entity will be a Registered GP: The converting entity must be a California Corp, LLC or LP; or Foreign Corp, LLC, LP or Other

Business Entity; File a Statement of Partnership Authority – Conversion (Form GP-1A)(PDF - REV 01/2016);

and The filing fee is $150 if a California Corp is involved; and $70 for all others. If the converted entity will be a Non-registering GP: The converting entity must be a California Corp, LLC or LP; or Registered Foreign Corp, LLC,

LP or Other Business Entity; File a Certificate of Conversion (Form CONV-1A)(PDF - REV 01/2016); and The filing fee is $150 if a California Corp is involved; and $30 for all others. If the converted entity will be a Foreign Entity: The converting entity must be a California LLC or LP, or Registered California GP; File a Certificate of Conversion (Form CONV-1A)(PDF - REV 01/2016); and The filing fee is $30.

Entity Mergers and Conversions:Entity Mergers and Conversions:State Laws and Tax LawsState Laws and Tax Laws A mere conversion is not regarded as a merger

for tax purposes.

◦ Under state conversion statues, a simple filing may, inmany instances, effect the conversion.

◦ The understanding of the tax consequences that occuris, nonetheless, essential, in understanding how one-step conversions are treated.

◦ Formless conversion statutes carry with them certaindeemed steps, one must be aware of these steps andchoose an alternative to the formless conversion if thedeemed steps aren’t desirable under the specific facts.


A mere conversion is not regarded as a mergerfor tax purposes.

◦ Under state conversion statues, a simple filing may, inmany instances, effect the conversion.

◦ The understanding of the tax consequences that occuris, nonetheless, essential, in understanding how one-step conversions are treated.

◦ Formless conversion statutes carry with them certaindeemed steps, one must be aware of these steps andchoose an alternative to the formless conversion if thedeemed steps aren’t desirable under the specific facts.

Entity Mergers and ConversionsEntity Mergers and Conversions

A series of Revenue Rulings address mergers andconversions involving partnerships and LLCs.

◦ Rev. Rul. 84-52, 1984-1 C.B. 157, conversion of a generalpartnership into a limited partnership.

◦ Rev. Rul. 95-37, 1995-1 C.B. 130, amplifies Rev. Rul. 84-52and applies the same approach to the conversion of a domesticpartnership to a domestic LLC that is classified as a partnership.Rev. Rul. 68-289, 168-1 C.B. 314 involves the mechanicsof the merger of three partnerships in an assets over form.

◦ Rev. Rul. 99-5, 1999-1 C.B. 434, conversion of a disregardedentity into a partnership.

◦ Rev. Rul. 99-6, 1996-1 C.B. 432, conversion of a partnershipinto a disregarded entity.

◦ Rev. Rul. 84-111, 1984-2 C.B. 88, incorporation of apartnership. This Revenue Ruling is also the touchstone for thekey constructs of how assets and liabilities are transferred,“assets over,” interests over” and “assets up.”


A series of Revenue Rulings address mergers andconversions involving partnerships and LLCs.

◦ Rev. Rul. 84-52, 1984-1 C.B. 157, conversion of a generalpartnership into a limited partnership.

◦ Rev. Rul. 95-37, 1995-1 C.B. 130, amplifies Rev. Rul. 84-52and applies the same approach to the conversion of a domesticpartnership to a domestic LLC that is classified as a partnership.Rev. Rul. 68-289, 168-1 C.B. 314 involves the mechanicsof the merger of three partnerships in an assets over form.

◦ Rev. Rul. 99-5, 1999-1 C.B. 434, conversion of a disregardedentity into a partnership.

◦ Rev. Rul. 99-6, 1996-1 C.B. 432, conversion of a partnershipinto a disregarded entity.

◦ Rev. Rul. 84-111, 1984-2 C.B. 88, incorporation of apartnership. This Revenue Ruling is also the touchstone for thekey constructs of how assets and liabilities are transferred,“assets over,” interests over” and “assets up.”

Incorporation of a PartnershipIncorporation of a Partnership

◦ Rev. Rul. 84-111 recognized that there were at least 3 ways for apartnership to convert to a corporation, each with unique taxconsequences, it was the first detailed pronouncement on suchsteps.

◦ Situation 1. The partnership transfers all of its assets to a newly-formedcorporation, in exchange for all the outstanding stock of the corporation and theassumption by the corporation of the partnership’s liabilities. The partnershipthen terminates by distributing all its stock to the partners of the partnership inproportion to their partnership interests. This is the so-called “assets over”approach.

◦ Situation 2. The partnership distributes all its assets and liabilities to its partnersin proportion to their partnership interests in a transaction that constitutes acomplete termination of the partnership under section 708(b)(1)(A). Thepartners then transfer all of the assets receive from the partnership to the newly-formed corporation in exchange for at he outstanding stock of the corporationand the assumption by the corporation of the liabilities that had been assumedby the partners. This is the so-called “assets up” approach.

◦ Situation 3. The partners transfer their partnership interests to a newly-formedcorporation in exchange for the outstanding stock of the corporation. Theexchange terminates the partnership and all of the assets and liabilities of thepartnership become assets and liabilities of the corporation. This is the so-called “partnership interest transfer” approach.


◦ Rev. Rul. 84-111 recognized that there were at least 3 ways for apartnership to convert to a corporation, each with unique taxconsequences, it was the first detailed pronouncement on suchsteps.

◦ Situation 1. The partnership transfers all of its assets to a newly-formedcorporation, in exchange for all the outstanding stock of the corporation and theassumption by the corporation of the partnership’s liabilities. The partnershipthen terminates by distributing all its stock to the partners of the partnership inproportion to their partnership interests. This is the so-called “assets over”approach.

◦ Situation 2. The partnership distributes all its assets and liabilities to its partnersin proportion to their partnership interests in a transaction that constitutes acomplete termination of the partnership under section 708(b)(1)(A). Thepartners then transfer all of the assets receive from the partnership to the newly-formed corporation in exchange for at he outstanding stock of the corporationand the assumption by the corporation of the liabilities that had been assumedby the partners. This is the so-called “assets up” approach.

◦ Situation 3. The partners transfer their partnership interests to a newly-formedcorporation in exchange for the outstanding stock of the corporation. Theexchange terminates the partnership and all of the assets and liabilities of thepartnership become assets and liabilities of the corporation. This is the so-called “partnership interest transfer” approach.


◦ One of the most significant differences in the 3 approaches toincorporation of the partnership is in the basis of the sharesreceived in the corporation

◦ Situation 1. In the “assets-over” approach, the basis of theshares received by the former partners is the basis of the assetscontributed, less liabilities assumed by the corporation.

◦ Situation 2. In the “assets-up” approach, the outside basis ofthe partners in their partnership interest (less money received)becomes the basis of the assets distributed. Upon contributionof these assets, the former partner receives a basis in theshares received equal to the basis of the assets contributed,less liabilities assumed by the corporation. Note that the insidebasis of the assets disappears, and the basis of the assetsbecomes the outside basis in the partnership interests. Thisconstruct is potentially of interest if there is a high outsidebasis and low inside basis.

◦ Situation 3. In the “partnership interest transfer” approach, thebasis the former partner receives in their shares, is the adjustedbasis of their partnership interest, less liabilities assumed bythe corporation.


◦ One of the most significant differences in the 3 approaches toincorporation of the partnership is in the basis of the sharesreceived in the corporation

◦ Situation 1. In the “assets-over” approach, the basis of theshares received by the former partners is the basis of the assetscontributed, less liabilities assumed by the corporation.

◦ Situation 2. In the “assets-up” approach, the outside basis ofthe partners in their partnership interest (less money received)becomes the basis of the assets distributed. Upon contributionof these assets, the former partner receives a basis in theshares received equal to the basis of the assets contributed,less liabilities assumed by the corporation. Note that the insidebasis of the assets disappears, and the basis of the assetsbecomes the outside basis in the partnership interests. Thisconstruct is potentially of interest if there is a high outsidebasis and low inside basis.

◦ Situation 3. In the “partnership interest transfer” approach, thebasis the former partner receives in their shares, is the adjustedbasis of their partnership interest, less liabilities assumed bythe corporation.


Electing Corporate Status Under the Check-the-Box Rules.◦ The “check-the-box” rules were promulgated after Rev.

Rul. 84-111◦ These rules permit an eligible entity to “check-the-box” or

elect an entity classification other than its defaultclassification.

◦ A domestic LLC, with two or more members is apartnership under the default classification.

◦ If it elects to be a corporation, there is a series of deemedsteps under section 301.7701-3(c)(l)(i).

◦ These deemed steps follow the “assets over” construct ofRev. Rul. 84-111.

◦ The following is deemed to occur: The unincorporated entity contributes all of its assets

and liabilities to the corporation in exchange for stock ofthe corporation;

Immediately thereafter, the unincorporated entity isliquidated, distributing the stock of the corporation toits partners.


Electing Corporate Status Under the Check-the-Box Rules.◦ The “check-the-box” rules were promulgated after Rev.

Rul. 84-111◦ These rules permit an eligible entity to “check-the-box” or

elect an entity classification other than its defaultclassification.

◦ A domestic LLC, with two or more members is apartnership under the default classification.

◦ If it elects to be a corporation, there is a series of deemedsteps under section 301.7701-3(c)(l)(i).

◦ These deemed steps follow the “assets over” construct ofRev. Rul. 84-111.

◦ The following is deemed to occur: The unincorporated entity contributes all of its assets

and liabilities to the corporation in exchange for stock ofthe corporation;

Immediately thereafter, the unincorporated entity isliquidated, distributing the stock of the corporation toits partners.


The good news:

Conversions of pass-through entities into other pass-through entities are often tax-free.

◦ GP to LP (Rev. Rul. 84-52); LP to LLC (Rev. Rul. 95-37) conversions.

◦ These rulings hold that Section 721 applies and there is no gain orloss under Section 741 and Section 1001.

◦ The rulings provide that, because the business will continue andbecause a 721 transaction is not treated as a sale or exchange, thereis no Section 708(b)(1)(A) or Section 708(b)(1)(B) termination.

◦ These rulings also provide that if liabilities shift, there will bedeemed distributions under Section 752(b). This could happen, forexample, in the shifting of liabilities if a GP converts to an LP or LLC.


The good news:

Conversions of pass-through entities into other pass-through entities are often tax-free.

◦ GP to LP (Rev. Rul. 84-52); LP to LLC (Rev. Rul. 95-37) conversions.

◦ These rulings hold that Section 721 applies and there is no gain orloss under Section 741 and Section 1001.

◦ The rulings provide that, because the business will continue andbecause a 721 transaction is not treated as a sale or exchange, thereis no Section 708(b)(1)(A) or Section 708(b)(1)(B) termination.

◦ These rulings also provide that if liabilities shift, there will bedeemed distributions under Section 752(b). This could happen, forexample, in the shifting of liabilities if a GP converts to an LP or LLC.

Entity ConversionsEntity Conversions

Tax Treatment of a Conversion of General Partnershipto Limited Partnership.◦ Rev. Rul. 84-52, 1984-1 C.B. 157, addresses the conversion of a general partnership interest into

a limited partnership interest as part of the conversion of the general partnership into a limitedpartnership.

◦ Rev. Rul. 84-52 provides that under Section 721, no gain or loss will be recognized to the partners(unless there is a deemed distribution of cash in excess of basis resulting from a shifting ofliabilities). It holds, further, that the partnership is a continuing partnership under Section 708,and does not terminate. Thus, it keeps its EIN and elections, and the conversion is not treated as amerger.

◦ Rev. Rul. 84-52 provides, “If, as a result of the conversion, there is no change in the partners’shares of [the Partnership’s] liabilities under section 1.752-1(e) of the regulations, there will ne nochange to the adjusted basis of any partner’s interest in [the Partnership] and [the Partners] willeach have a single adjusted basis with respect to each partner’s interest in [the Partnership] (bothas limited partners and general partner) equal to the adjusted basis of each partner’s respectivegeneral partnership interest in [the Partnership] prior to conversion.”

◦ Rev. Rul. 84-52 further states, “If, as a result of the conversion, there is a change in the partnersshares of [the Partnership’s] liabilities under section 1.752-1(e) of the regulations, and suchchange causes a deemed contribution of money to [the Partnership] by a partner under Section752(a) of the Code, then the adjusted basis of that partner’s interest shall, under section 722 ofthe Code, be increased by the amount of such deemed contribution. If the change in the partnersshares of liabilities causes a deemed distribution of money to a partner under Section 752(b) of theCode, then the basis of that partner’s interest shall, under section 733 of the Code, be reduced(but not below zero) by the amount of such deemed distribution, and any gain will be recognizedby that partner under Section 731 of the Code to the extent the deemed distribution exceeds thetotal adjusted basis of that partner’s interest in [the Partnership].”

◦ Consequence There is no deemed distribution out of assets and no automatic gain, but theshifting of liabilities must be taken into account in determining whether there is, in fact, any gainto any partner or any change in partners’ bases.


Tax Treatment of a Conversion of General Partnershipto Limited Partnership.◦ Rev. Rul. 84-52, 1984-1 C.B. 157, addresses the conversion of a general partnership interest into

a limited partnership interest as part of the conversion of the general partnership into a limitedpartnership.

◦ Rev. Rul. 84-52 provides that under Section 721, no gain or loss will be recognized to the partners(unless there is a deemed distribution of cash in excess of basis resulting from a shifting ofliabilities). It holds, further, that the partnership is a continuing partnership under Section 708,and does not terminate. Thus, it keeps its EIN and elections, and the conversion is not treated as amerger.

◦ Rev. Rul. 84-52 provides, “If, as a result of the conversion, there is no change in the partners’shares of [the Partnership’s] liabilities under section 1.752-1(e) of the regulations, there will ne nochange to the adjusted basis of any partner’s interest in [the Partnership] and [the Partners] willeach have a single adjusted basis with respect to each partner’s interest in [the Partnership] (bothas limited partners and general partner) equal to the adjusted basis of each partner’s respectivegeneral partnership interest in [the Partnership] prior to conversion.”

◦ Rev. Rul. 84-52 further states, “If, as a result of the conversion, there is a change in the partnersshares of [the Partnership’s] liabilities under section 1.752-1(e) of the regulations, and suchchange causes a deemed contribution of money to [the Partnership] by a partner under Section752(a) of the Code, then the adjusted basis of that partner’s interest shall, under section 722 ofthe Code, be increased by the amount of such deemed contribution. If the change in the partnersshares of liabilities causes a deemed distribution of money to a partner under Section 752(b) of theCode, then the basis of that partner’s interest shall, under section 733 of the Code, be reduced(but not below zero) by the amount of such deemed distribution, and any gain will be recognizedby that partner under Section 731 of the Code to the extent the deemed distribution exceeds thetotal adjusted basis of that partner’s interest in [the Partnership].”

◦ Consequence There is no deemed distribution out of assets and no automatic gain, but theshifting of liabilities must be taken into account in determining whether there is, in fact, any gainto any partner or any change in partners’ bases.


Tax Treatment of a Conversion of GeneralPartnership to Limited Partnership.

◦ 752(b) issue:

Assume A and B form general partnership, P, which hasproperty with a FMV of 400, AB of 160 and liabilities of 200.

If the partnership converts from a general partnership to anLP and A is the general partner and B is the limited partner,the 160 is included entirely in A’s basis and none of the 160is included in B’s basis.


Tax Treatment of a Conversion of GeneralPartnership to Limited Partnership.

◦ 752(b) issue:

Assume A and B form general partnership, P, which hasproperty with a FMV of 400, AB of 160 and liabilities of 200.

If the partnership converts from a general partnership to anLP and A is the general partner and B is the limited partner,the 160 is included entirely in A’s basis and none of the 160is included in B’s basis.


Tax Treatment of a Conversion of a Domestic Partnershipto a Limited Liability Company.◦ Rev. Rul. 95-37, 1995-1 C.B. 130 amplifies Rev. Rul. 84-52 and applies the same

approach as Rev. Rul. 84-52 to the conversion from a domestic partnership to adomestic limited liability company (“LLC”) that is classified as a partnership. Theconversion is not treated as a merger.

◦ Rev. Rul. 95-37 provides similarly to Rev. Rul. 84-52 that the conversion is generallytax-free under Section 721 (rather than a sale or exchange) and provides that there is notermination of the partnership, and that it retains its EIN.

◦ Rev. Rul. 95-37 provides, more succinctly, that the key issue is whether and the extent towhich partner’s shares of liabilities change, it provides, in pertinent part, “(3) if thepartners’ shares of partnership liabilities do not change, there will be no change in theadjusted basis of any partner’s interest in the partnership, (4) if the partners’ shares ofpartnership liabilities change and cause a deemed contribution of money to thepartnership under section 752(a), then the adjusted basis of such a partner’s interest willbe increased under section 722 by the amount of the deemed contribution, (5) if thepartners’ shares of partnership liabilities change and cause a deemed distribution ofmoney by the partnership to a partner under section 752(b), then the basis of such apartner’s interest will be reduced under section 733 (but not below zero) by the amountof the deemed distribution, and gain will be recognized by the partner under section 731to the extent the deemed distribution exceeds the adjusted basis of the partner’s interestin the partnership.”

◦ Consequence There is no deemed distribution out of assets and no automatic gain,but the shifting of liabilities must be taken into account in determining whether there is,in fact, any gain to any partner or any change in partners’ bases.


Tax Treatment of a Conversion of a Domestic Partnershipto a Limited Liability Company.◦ Rev. Rul. 95-37, 1995-1 C.B. 130 amplifies Rev. Rul. 84-52 and applies the same

approach as Rev. Rul. 84-52 to the conversion from a domestic partnership to adomestic limited liability company (“LLC”) that is classified as a partnership. Theconversion is not treated as a merger.

◦ Rev. Rul. 95-37 provides similarly to Rev. Rul. 84-52 that the conversion is generallytax-free under Section 721 (rather than a sale or exchange) and provides that there is notermination of the partnership, and that it retains its EIN.

◦ Rev. Rul. 95-37 provides, more succinctly, that the key issue is whether and the extent towhich partner’s shares of liabilities change, it provides, in pertinent part, “(3) if thepartners’ shares of partnership liabilities do not change, there will be no change in theadjusted basis of any partner’s interest in the partnership, (4) if the partners’ shares ofpartnership liabilities change and cause a deemed contribution of money to thepartnership under section 752(a), then the adjusted basis of such a partner’s interest willbe increased under section 722 by the amount of the deemed contribution, (5) if thepartners’ shares of partnership liabilities change and cause a deemed distribution ofmoney by the partnership to a partner under section 752(b), then the basis of such apartner’s interest will be reduced under section 733 (but not below zero) by the amountof the deemed distribution, and gain will be recognized by the partner under section 731to the extent the deemed distribution exceeds the adjusted basis of the partner’s interestin the partnership.”

◦ Consequence There is no deemed distribution out of assets and no automatic gain,but the shifting of liabilities must be taken into account in determining whether there is,in fact, any gain to any partner or any change in partners’ bases.

Entity ConversionsEntity Conversions Formless Conversion: Treatment of Conversion of a

Partnership or LLC to a Corporation Where The State LawStatute Does Not Define the Form of the Conversion.

◦ Where there is a formless conversion statute, Rev. Rul. 2004-59 provides for thesame “deemed” steps as a check-the-box election under section 301.7701-3(c)(l)(i).

◦ The following is deemed to occur: The unincorporated entity contributes all of its assets and liabilities to the

corporation in exchange for stock of the corporation; Immediately thereafter, the unincorporated entity is liquidated, distributing the stock

of the corporation to its partners.

◦ Although Rev. Rul. 84-111 technically does not apply, this construct is the“assets-over” approach of situation 1 of Rev. Rul. 84-111.

◦ If treatment under a different construct of Rev. Rul. 84-111 is desired, use analternative to a formless conversion statute.

◦ If the new corporation is going to elect Subchapter S treatment, does themomentary ownership of the stock by an ineligible shareholder (a partnership)prevent an immediate S election after the incorporation? No, see Rev. Rul. 2009-15. The same holds true whether the incorporation is made via a “check-the-box” election (Situation 1 of Rev. Rul. 2009-15) or via a formless conversionstatute (Situation 2 of Rev. Rul. 2009-15).


Formless Conversion: Treatment of Conversion of aPartnership or LLC to a Corporation Where The State LawStatute Does Not Define the Form of the Conversion.

◦ Where there is a formless conversion statute, Rev. Rul. 2004-59 provides for thesame “deemed” steps as a check-the-box election under section 301.7701-3(c)(l)(i).

◦ The following is deemed to occur: The unincorporated entity contributes all of its assets and liabilities to the

corporation in exchange for stock of the corporation; Immediately thereafter, the unincorporated entity is liquidated, distributing the stock

of the corporation to its partners.

◦ Although Rev. Rul. 84-111 technically does not apply, this construct is the“assets-over” approach of situation 1 of Rev. Rul. 84-111.

◦ If treatment under a different construct of Rev. Rul. 84-111 is desired, use analternative to a formless conversion statute.

◦ If the new corporation is going to elect Subchapter S treatment, does themomentary ownership of the stock by an ineligible shareholder (a partnership)prevent an immediate S election after the incorporation? No, see Rev. Rul. 2009-15. The same holds true whether the incorporation is made via a “check-the-box” election (Situation 1 of Rev. Rul. 2009-15) or via a formless conversionstatute (Situation 2 of Rev. Rul. 2009-15).

Conversions vs. MergersConversions vs. Mergers

Conversions are Not Mergers:

◦ A mere conversion of a partnership (for example a conversionof a GP to an LP or LLC under a state law conversion statute) isnot regarded as a merger, even though it may be accomplishedthrough a merger under state law.

◦ Thus, there is no terminating partnership and no continuingpartnership. Rather, the converted entity is the samepartnership as before the conversion. Elections remain thesame and the EIN remains the same.


Conversions are Not Mergers:

◦ A mere conversion of a partnership (for example a conversionof a GP to an LP or LLC under a state law conversion statute) isnot regarded as a merger, even though it may be accomplishedthrough a merger under state law.

◦ Thus, there is no terminating partnership and no continuingpartnership. Rather, the converted entity is the samepartnership as before the conversion. Elections remain thesame and the EIN remains the same.


The bad news:

Conversions of C corporations or S corporations to LLCsor partnerships are taxable.◦ S corp. to LLC: PLR 9543017.

◦ C corp. to LLC: PLR 9701029.

◦ Both are taxable, yet both can be easily accomplished under many states’merger statutes.

◦ Special case: S corp. can merger into LLC tax-free, if the LLC immediatelyelects to be taxed as a corp. and elects S status. There is a PLR on this,which is occasionally incorrectly cited for the proposition that aconversion of an S corp. to an LLC is tax-free. It isn’t unless the LLCimmediately elects S status. PLR 9409014. The LLC interests weredistributed to parent under 332, 336, no gain or loss. PLR 9409014.


The bad news:

Conversions of C corporations or S corporations to LLCsor partnerships are taxable.◦ S corp. to LLC: PLR 9543017.

◦ C corp. to LLC: PLR 9701029.

◦ Both are taxable, yet both can be easily accomplished under many states’merger statutes.

◦ Special case: S corp. can merger into LLC tax-free, if the LLC immediatelyelects to be taxed as a corp. and elects S status. There is a PLR on this,which is occasionally incorrectly cited for the proposition that aconversion of an S corp. to an LLC is tax-free. It isn’t unless the LLCimmediately elects S status. PLR 9409014. The LLC interests weredistributed to parent under 332, 336, no gain or loss. PLR 9409014.

Conversion of an S corporation toConversion of an S corporation toan LLC.an LLC.

◦ PLR 9543017 – The Conversion of an S corporation to an LLC is taxable.

◦ The PLR addressed the State law merger of an S corporation into an LLC, with the LLCsurviving.

◦ The PLR provides that the merger of the S corporation into the LLC, with the LLCsurviving is treated as the transfer of the S corporation assets to the LLC in exchange forthe LLC’s assumption of the S corporation’s liabilities, followed by the S corporation’sreceipt of an interest in the LLC, and the S corporation’s distribution of the LLC to itsshareholders in complete liquidation of the S corporation.

◦ The PLR provides that no gain or loss will result to the S corporation or the LLC on thecontribution of assets to the LLC, unless the S corporation receives a net decrease inliabilities exceeding its basis in the assets contributed under section 1.752-1(f) of theregulations (and provided that the LLC would not be treated as an investment company ifit incorporated).

◦ The PLR provides, however, that the S corporation will recognize gain or loss on thedistribution of the interest in the LLC to its shareholders in complete liquidation, as if theS corporation had sold the interest to its shareholders at the time of liquidation. The PLRprovides that this gain or loss will be passed through to the S corporation shareholdersunder section 1366(a).

◦ Thus, a fairly simple merger or conversion, under State law, of an S corporation to an LLCis taxable under Section 331 to the extent the value of the interests in thepartnership/LLC received exceeds the shareholder’s basis in the S corporation stock.

◦ If an S corporation is not desirable going forward, there are at least two alternatives toconverting the entire S corporation, including having the S corporation become a memberin a lower-tier LLC, or a multi-step transaction described later.


◦ PLR 9543017 – The Conversion of an S corporation to an LLC is taxable.

◦ The PLR addressed the State law merger of an S corporation into an LLC, with the LLCsurviving.

◦ The PLR provides that the merger of the S corporation into the LLC, with the LLCsurviving is treated as the transfer of the S corporation assets to the LLC in exchange forthe LLC’s assumption of the S corporation’s liabilities, followed by the S corporation’sreceipt of an interest in the LLC, and the S corporation’s distribution of the LLC to itsshareholders in complete liquidation of the S corporation.

◦ The PLR provides that no gain or loss will result to the S corporation or the LLC on thecontribution of assets to the LLC, unless the S corporation receives a net decrease inliabilities exceeding its basis in the assets contributed under section 1.752-1(f) of theregulations (and provided that the LLC would not be treated as an investment company ifit incorporated).

◦ The PLR provides, however, that the S corporation will recognize gain or loss on thedistribution of the interest in the LLC to its shareholders in complete liquidation, as if theS corporation had sold the interest to its shareholders at the time of liquidation. The PLRprovides that this gain or loss will be passed through to the S corporation shareholdersunder section 1366(a).

◦ Thus, a fairly simple merger or conversion, under State law, of an S corporation to an LLCis taxable under Section 331 to the extent the value of the interests in thepartnership/LLC received exceeds the shareholder’s basis in the S corporation stock.

◦ If an S corporation is not desirable going forward, there are at least two alternatives toconverting the entire S corporation, including having the S corporation become a memberin a lower-tier LLC, or a multi-step transaction described later.

Conversion of a C corporation toConversion of a C corporation toan LLCan LLC

◦ PLR 9701029 – The conversion of a C corporation to an LLC is taxable.

◦ The PLR addressed the State law merger of a C corporation into an LLC,with the LLC surviving.

◦ This PLR follows the some construct as PLR 9543017, the merger of the Ccorporation into the LLC, with the LLC surviving is treated as the transferof the C corporation assets to the LLC in exchange for the LLC’sassumption of the C corporation’s liabilities, followed by the Ccorporation’s receipt of an interest in the LLC, and the C corporation’sdistribution of the LLC to its shareholders in complete liquidation of the Ccorporation.

◦ This liquidation is taxable under section 331.

◦ The C corporation will recognize gain or loss on the distribution of themembership interests in the LLC to the shareholders as if the interests hadbeen sold to the shareholders for its fair market value.


◦ PLR 9701029 – The conversion of a C corporation to an LLC is taxable.

◦ The PLR addressed the State law merger of a C corporation into an LLC,with the LLC surviving.

◦ This PLR follows the some construct as PLR 9543017, the merger of the Ccorporation into the LLC, with the LLC surviving is treated as the transferof the C corporation assets to the LLC in exchange for the LLC’sassumption of the C corporation’s liabilities, followed by the Ccorporation’s receipt of an interest in the LLC, and the C corporation’sdistribution of the LLC to its shareholders in complete liquidation of the Ccorporation.

◦ This liquidation is taxable under section 331.

◦ The C corporation will recognize gain or loss on the distribution of themembership interests in the LLC to the shareholders as if the interests hadbeen sold to the shareholders for its fair market value.


An easy way of thinking of conversions and mergers is tobreak them down into different categories.

Mergers or conversions of pass-through entities:◦ GP to LP (Rev. Rul. 84-52); LP to LLC (Rev. Rul. 95-37) conversions.◦ Pass through mergers. Section 708(b)(2)(A); Treas. Reg. Section 1.708-1(c)

(coming up).

Mergers or conversions that are for tax purposes, only.◦ Disregarded entity to a partnership (Rev. Rul. 99-5)◦ Partnership to a disregarded entity (Rev. Rul. 99-6)◦ Check-the-box

Incorporation.◦ Rev. Rul. 84-111◦ Incorporation is also the treatment of conversion of an LLC to an S corp. or

C corp.

Corporation to pass-through.◦ PLR 9543017, S corp. to LLC; PLR 9701029, C corp. to LLC


An easy way of thinking of conversions and mergers is tobreak them down into different categories.

Mergers or conversions of pass-through entities:◦ GP to LP (Rev. Rul. 84-52); LP to LLC (Rev. Rul. 95-37) conversions.◦ Pass through mergers. Section 708(b)(2)(A); Treas. Reg. Section 1.708-1(c)

(coming up).

Mergers or conversions that are for tax purposes, only.◦ Disregarded entity to a partnership (Rev. Rul. 99-5)◦ Partnership to a disregarded entity (Rev. Rul. 99-6)◦ Check-the-box

Incorporation.◦ Rev. Rul. 84-111◦ Incorporation is also the treatment of conversion of an LLC to an S corp. or

C corp.

Corporation to pass-through.◦ PLR 9543017, S corp. to LLC; PLR 9701029, C corp. to LLC

Entity Mergers and ConversionsEntity Mergers and Conversions The more complicated analysis: Mergers of two or more pass-through

entities.

The corporate tax rules on mergers are very form-driven.

◦ There are certain detailed requirements for different types of Mergersunder Section 368.

Type A reorgs are fairly flexible, with up to at least 50% boot permitted. Type B reorgs carry more requirements, as do Type C and D reorgs. Type E and F reorgs are generally single-entity reorgs, Type G is

bankruptcy.

◦ Even the Section 351 rules require an 80% control group obtaining theirinterest for property, and gain can be recognized where liabilities exceedbasis of the property contributed under Section (c).

◦ In contrast, the rules of Subchapter K, the partnership rules, contain verylittle guidance on partnership mergers. Section 708(b)(2)(A) addresseswhich partnership, if any, is treated as a continuation of any merging orconsolidating partnership, but it does not contain detailed rules onpartnership mergers.


The more complicated analysis: Mergers of two or more pass-throughentities.

The corporate tax rules on mergers are very form-driven.

◦ There are certain detailed requirements for different types of Mergersunder Section 368.

Type A reorgs are fairly flexible, with up to at least 50% boot permitted. Type B reorgs carry more requirements, as do Type C and D reorgs. Type E and F reorgs are generally single-entity reorgs, Type G is

bankruptcy.

◦ Even the Section 351 rules require an 80% control group obtaining theirinterest for property, and gain can be recognized where liabilities exceedbasis of the property contributed under Section (c).

◦ In contrast, the rules of Subchapter K, the partnership rules, contain verylittle guidance on partnership mergers. Section 708(b)(2)(A) addresseswhich partnership, if any, is treated as a continuation of any merging orconsolidating partnership, but it does not contain detailed rules onpartnership mergers.


In a merger, the deemed tax steps and the stepsoccurring under state law can differ.

This can result in one entity surviving for state lawpurposes, while a different entity is deemed to survivefrom a tax law perspective.

A “worst case scenario” is that because cross-speciemergers and conversions are deceptively simple understate law, tax considerations may be addressed late in theprocess, or not at all. This could result, for example in anentity conversion being undertaken that is taxable.

Even apart from this simplistic problem that could occurwhere there is little legal guidance, there are moresophisticated situations in which there could be gainresulting from the shifting of liabilities, or 704(c) or 737“mixing bowl” rules.


In a merger, the deemed tax steps and the stepsoccurring under state law can differ.

This can result in one entity surviving for state lawpurposes, while a different entity is deemed to survivefrom a tax law perspective.

A “worst case scenario” is that because cross-speciemergers and conversions are deceptively simple understate law, tax considerations may be addressed late in theprocess, or not at all. This could result, for example in anentity conversion being undertaken that is taxable.

Even apart from this simplistic problem that could occurwhere there is little legal guidance, there are moresophisticated situations in which there could be gainresulting from the shifting of liabilities, or 704(c) or 737“mixing bowl” rules.

Partnership Rules vs. CorporatePartnership Rules vs. CorporateTax RulesTax Rules

The only specific section of the Code dealing withpartnership mergers is Section 708(b)(2)(A). Treas.Reg. Section 1.708-1(c) also addresses partnershipmergers.

There are two types of partnership terminations, an“actual termination” under Section 708(b)(1)(A) and a“technical termination” under Section 708(b)(1)(B).

Section 708(b)(2)(A) provides which partnership, if any,is treated as “continuing.” Section 708(b)(2)(A)provides,“In the case of the merger or consolidation of two or more partnerships, theresulting partnership shall, for purposes of this section, be considered thecontinuation of any merging or consolidating partnership whose membersown an interest of more than 50 percent in the capital and profits of theresulting partnership.”


The only specific section of the Code dealing withpartnership mergers is Section 708(b)(2)(A). Treas.Reg. Section 1.708-1(c) also addresses partnershipmergers.

There are two types of partnership terminations, an“actual termination” under Section 708(b)(1)(A) and a“technical termination” under Section 708(b)(1)(B).

Section 708(b)(2)(A) provides which partnership, if any,is treated as “continuing.” Section 708(b)(2)(A)provides,“In the case of the merger or consolidation of two or more partnerships, theresulting partnership shall, for purposes of this section, be considered thecontinuation of any merging or consolidating partnership whose membersown an interest of more than 50 percent in the capital and profits of theresulting partnership.”


Unlike the corporate rules, there are no specific forms ofpartnership mergers afforded tax-free treatment.

Any partnership merger is tested under the normalpartnership rules, including Section 721, 722, 723, 731,751, and Section 704 and Section 737. Rev. Rul. 2004-43contains examples re 704(b) gain and 737 mixing bowlrules.

The partnership rules are, in general, more flexible thanthe corporate rules.◦ There is no requirement for a “control group” akin to Section 351, indeed a

contribution of property to a partnership is generally tax-free irrespective of thepercentage of interest received in exchange for the property.

◦ The contribution of liabilities to a partnership is not tested against basis of theproperty contributed like Section 351, but liabilities assumed and relieved mustbe netted and tested under Section 752(b) and a net reduction in liabilities is adeemed distribution of cash.

◦ Even with a deemed distribution of cash (resulting from a net reduction inliabilities), there may not be gain, since a partner only recognizes gain on anactual or deemed distribution of cash if it exceeds the partner’s adjusted basis inthe partners’ partnership interest.


Unlike the corporate rules, there are no specific forms ofpartnership mergers afforded tax-free treatment.

Any partnership merger is tested under the normalpartnership rules, including Section 721, 722, 723, 731,751, and Section 704 and Section 737. Rev. Rul. 2004-43contains examples re 704(b) gain and 737 mixing bowlrules.

The partnership rules are, in general, more flexible thanthe corporate rules.◦ There is no requirement for a “control group” akin to Section 351, indeed a

contribution of property to a partnership is generally tax-free irrespective of thepercentage of interest received in exchange for the property.

◦ The contribution of liabilities to a partnership is not tested against basis of theproperty contributed like Section 351, but liabilities assumed and relieved mustbe netted and tested under Section 752(b) and a net reduction in liabilities is adeemed distribution of cash.

◦ Even with a deemed distribution of cash (resulting from a net reduction inliabilities), there may not be gain, since a partner only recognizes gain on anactual or deemed distribution of cash if it exceeds the partner’s adjusted basis inthe partners’ partnership interest.

Partnership Rules vs.Partnership Rules vs.Corporate Tax RulesCorporate Tax Rules

Partnership AB, in whose capital and profits A and B each own a 50-percent interest, and partnership CD, in whose capital and profits C andD each own a 50-percent interest, merge on September 30, 1999, andform partnership ABCD. Partners A, B, C, and D are on a calendar year,and partnership AB and partnership CD also are on a calendar year.After the merger, the partners have capital and profits interests asfollows: A, 30 percent; B, 30 percent; C, 20 percent; and D, 20 percent.Since A and B together own an interest of more than 50 percent in thecapital and profits of partnership ABCD, such partnership shall beconsidered a continuation of partnership AB and shall continue to filereturns on a calendar year basis. Since C and D own an interest of lessthan 50 percent in the capital and profits of partnership ABCD, thetaxable year of partnership CD closes as of September 30, 1999, thedate of the merger, and partnership CD is terminated as of that date.Partnership ABCD is required to file a return for the taxable yearJanuary 1 to December 31, 1999, indicating thereon that, untilSeptember 30, 1999, it was partnership AB. Partnership CD is requiredto file a return for its final taxable year, January 1 through September30, 1999. Example 1, Treas. Reg. Section 1.708-1(c)(5), Example 1.


Partnership AB, in whose capital and profits A and B each own a 50-percent interest, and partnership CD, in whose capital and profits C andD each own a 50-percent interest, merge on September 30, 1999, andform partnership ABCD. Partners A, B, C, and D are on a calendar year,and partnership AB and partnership CD also are on a calendar year.After the merger, the partners have capital and profits interests asfollows: A, 30 percent; B, 30 percent; C, 20 percent; and D, 20 percent.Since A and B together own an interest of more than 50 percent in thecapital and profits of partnership ABCD, such partnership shall beconsidered a continuation of partnership AB and shall continue to filereturns on a calendar year basis. Since C and D own an interest of lessthan 50 percent in the capital and profits of partnership ABCD, thetaxable year of partnership CD closes as of September 30, 1999, thedate of the merger, and partnership CD is terminated as of that date.Partnership ABCD is required to file a return for the taxable yearJanuary 1 to December 31, 1999, indicating thereon that, untilSeptember 30, 1999, it was partnership AB. Partnership CD is requiredto file a return for its final taxable year, January 1 through September30, 1999. Example 1, Treas. Reg. Section 1.708-1(c)(5), Example 1.


Mechanics of Continuation Assets-Over Form.

◦ A partnership merger is treated as an “assets over”transfer, unless specifically structured as “assets up.”Treas. Reg. Section 1.708-1(c)(3).

◦ In the assets-over form, assets of the terminatedpartnership are treated as contributed to the continuingpartnership, in exchange for an interest in the“resulting partnership,” and, immediately thereafter, theterminating partnership is treated as distributing theinterest in the resulting partnership to its partners inliquidation of the terminated partnership.

◦ An assets-up form can be selected. A transitorydistribution of assets to partners, followed by arecontribution is respected, despite the transitoryownership. Treas. Reg. Section 1.708-1(c)(3)(ii). But,note Example 6 of Treas. Reg. Section 1.708-1(c)(6)(ii).

◦ If certain requirements are met, a sale by a partner in aterminating partnership to a resulting partnership willbe respected. Treas. Reg. Section 1.708-1(c)(4).


Mechanics of Continuation Assets-Over Form.

◦ A partnership merger is treated as an “assets over”transfer, unless specifically structured as “assets up.”Treas. Reg. Section 1.708-1(c)(3).

◦ In the assets-over form, assets of the terminatedpartnership are treated as contributed to the continuingpartnership, in exchange for an interest in the“resulting partnership,” and, immediately thereafter, theterminating partnership is treated as distributing theinterest in the resulting partnership to its partners inliquidation of the terminated partnership.

◦ An assets-up form can be selected. A transitorydistribution of assets to partners, followed by arecontribution is respected, despite the transitoryownership. Treas. Reg. Section 1.708-1(c)(3)(ii). But,note Example 6 of Treas. Reg. Section 1.708-1(c)(6)(ii).

◦ If certain requirements are met, a sale by a partner in aterminating partnership to a resulting partnership willbe respected. Treas. Reg. Section 1.708-1(c)(4).


So, are all mergers between partnerships andpartnerships or LLCs taxed as partnerships tax-free?

No!

◦ There are potential shifts in liabilities. The 752(b) rules netthese and only a net reduction with a deemed distribution inexcess of basis triggers gain, but shifting will impact basis,even if it doesn’t exceed basis.

◦ 704(c) and 737 can trigger gain, even when there is no actualdistribution. Rev. Rul. 2004-43.


So, are all mergers between partnerships andpartnerships or LLCs taxed as partnerships tax-free?

No!

◦ There are potential shifts in liabilities. The 752(b) rules netthese and only a net reduction with a deemed distribution inexcess of basis triggers gain, but shifting will impact basis,even if it doesn’t exceed basis.

◦ 704(c) and 737 can trigger gain, even when there is no actualdistribution. Rev. Rul. 2004-43.

AssetsAssets--OverOver

P1

Terminating

P2

Continuing

Assets andLiabilities

Interests inP2

A B C D

1

Interests inP2

2

©2016 Glaser Weil Fink Howard Avchen & Shapiro LLP 30

P1

Terminating

P2

Continuing

P1 contributes all assets and liabilities inP2, in exchange for an interest in P2

P1 distributes the interests in P2 to A and Band terminates

Interests inP2

1

2

Treas. Reg. Section 1.708-2(c)(3)(i)

AssetsAssets--OverOver

P1

Terminating

P2

Continuing

Assets andLiabilities

Interests inP2

A B C D

1

Interests inP2

2


P1

Terminating

P2

Continuing

Sections 721, 722, and 723 apply. The tax basis of theassets contributed thus generally remains the same asprior to contribution.Sections 704(c)(1)(B) and 737 do not apply.

Interests inP2

Treas. Reg. Section 1.708-2(c)(3)(i)

AssetsAssets--UpUp

P1 P2

A B C D

1

Assets

Assets

2


P1 P2

P1’s assets are distributed to A and B inliquidation of P1

A and B contribute assets to P2

1

2

Treas. Reg. Section 1.708-2(c)(3)(ii)

AssetsAssets--UpUp

P1 P2

A B C D

1

2 Assets

Assets


P1 P2

The assets are distributed, with their bases determined underSections 732(b) and (c) on distribution, and then 723 oncontribution. Basis in the assets will thus change based on“outside basis.”

Sections 704(c)(1)(B) and 737 apply.

Treas. Reg. Section 1.708-2(c)(3)(ii)


Continuation of the Partnership◦ Section 708(b)(2)(A) dictates which partnership continues and which

terminates.

◦ Rev. Rul. 68-289, 1968-1 C.B. 314 provides that the partners in thenon-continuing partnership are treated as contributing all of theirassets and liabilities to the continuing partnership, in exchange foran interest in the continuing partnership. (“Asssets-Over”). Rev. Rul.90-17 provides similarly.

◦ If partners of one of the merging partnership do not own more than50% of the capital and profits of the resulting partnership, there isno continuing partnership, rather both are new partnerships.

◦ Rev. Rul. 68-289, 168-1 C.B. 314 involves the mechanics of themerger of three partnerships in an assets over form.

◦ If there is more than one continuing partnership, then there are rules as towhich resulting partnership is treated as the continuing partnership. Rev.Rul. 77-458, 1977-2 C.B. 220. Which continues depends upon the FMVof the assets contributed. The partnership with the highest FMV of assetsis treated as the continuing partnership.


Continuation of the Partnership◦ Section 708(b)(2)(A) dictates which partnership continues and which

terminates.

◦ Rev. Rul. 68-289, 1968-1 C.B. 314 provides that the partners in thenon-continuing partnership are treated as contributing all of theirassets and liabilities to the continuing partnership, in exchange foran interest in the continuing partnership. (“Asssets-Over”). Rev. Rul.90-17 provides similarly.

◦ If partners of one of the merging partnership do not own more than50% of the capital and profits of the resulting partnership, there isno continuing partnership, rather both are new partnerships.

◦ Rev. Rul. 68-289, 168-1 C.B. 314 involves the mechanics of themerger of three partnerships in an assets over form.

◦ If there is more than one continuing partnership, then there are rules as towhich resulting partnership is treated as the continuing partnership. Rev.Rul. 77-458, 1977-2 C.B. 220. Which continues depends upon the FMVof the assets contributed. The partnership with the highest FMV of assetsis treated as the continuing partnership.


Why is it important which partnership (ifany) is treated as continuing?◦ Elections of the continuing partnership remain

in place.

◦ The EIN of the continuing partnership remainsthe same.

◦ Which partnership “continues” determines theconstruct of the transaction for tax purposes,that is which partnership is treated ascontributing assets and which partnership istreated as distributing assets.


Why is it important which partnership (ifany) is treated as continuing?◦ Elections of the continuing partnership remain

in place.

◦ The EIN of the continuing partnership remainsthe same.

◦ Which partnership “continues” determines theconstruct of the transaction for tax purposes,that is which partnership is treated ascontributing assets and which partnership istreated as distributing assets.


There could be no continuing partnership or therecould be more than one continuing partnership.

◦ If partners of one of the merging partnership do not ownmore than 50% of the capital and profits of the resultingpartnership, there is no continuing partnership, rather bothare new partnerships.


There could be no continuing partnership or therecould be more than one continuing partnership.

◦ If partners of one of the merging partnership do not ownmore than 50% of the capital and profits of the resultingpartnership, there is no continuing partnership, rather bothare new partnerships.

Partnership Rules vs. CorporatePartnership Rules vs. CorporateTax RulesTax Rules The partnership that continues for tax purposes could differ from

the partnership that continues under state law. Treas. Reg. 1.708-1(c)(5), Example 2.

(i) Partnership X, in whose capital and profits A owns a 40-percent interest and Bowns a 60-percent interest, and partnership Y, in whose capital and profits B owns a60-percent interest and C owns a 40-percent interest, merge on September 30,1999. The fair market value of the partnership X assets (net of liabilities) is $100X,and the fair market value of the partnership Y assets (net of liabilities) is $200X. Themerger is accomplished under state law by partnership Y contributing its assets andliabilities to partnership X in exchange for interests in partnership X, withpartnership Y then liquidating, distributing interests in partnership X to B and C.

(ii) B, a partner in both partnerships prior to the merger, owns a greater than 50-percent interest in the resulting partnership following the merger. Accordingly,because the fair market value of partnership Y's assets (net of liabilities) was greaterthan that of partnership X's, under paragraph (c)(1) of this section, partnership X willbe considered to terminate in the merger. As a result, even though, for state lawpurposes, the transaction was undertaken with partnership Y contributing its assetsand liabilities to partnership X and distributing interests in partnership X to itspartners, pursuant to paragraph (c)(3)(i) of this section, for Federal income taxpurposes, the transaction will be treated as if partnership X contributed its assets topartnership Y in exchange for interests in partnership Y and then liquidated,distributing interests in partnership Y to A and B.


The partnership that continues for tax purposes could differ fromthe partnership that continues under state law. Treas. Reg. 1.708-1(c)(5), Example 2.

(i) Partnership X, in whose capital and profits A owns a 40-percent interest and Bowns a 60-percent interest, and partnership Y, in whose capital and profits B owns a60-percent interest and C owns a 40-percent interest, merge on September 30,1999. The fair market value of the partnership X assets (net of liabilities) is $100X,and the fair market value of the partnership Y assets (net of liabilities) is $200X. Themerger is accomplished under state law by partnership Y contributing its assets andliabilities to partnership X in exchange for interests in partnership X, withpartnership Y then liquidating, distributing interests in partnership X to B and C.

(ii) B, a partner in both partnerships prior to the merger, owns a greater than 50-percent interest in the resulting partnership following the merger. Accordingly,because the fair market value of partnership Y's assets (net of liabilities) was greaterthan that of partnership X's, under paragraph (c)(1) of this section, partnership X willbe considered to terminate in the merger. As a result, even though, for state lawpurposes, the transaction was undertaken with partnership Y contributing its assetsand liabilities to partnership X and distributing interests in partnership X to itspartners, pursuant to paragraph (c)(3)(i) of this section, for Federal income taxpurposes, the transaction will be treated as if partnership X contributed its assets topartnership Y in exchange for interests in partnership Y and then liquidated,distributing interests in partnership Y to A and B.


Special Problems.

◦ Rev. Rul. 2004-43, 2004-4 C.B. 842 addresses 704(c)(1)(B)and 737(b).

In an “assets-over” construct, the seven year holding period doesnot restart. Treas. Reg. Section 1.704-4(c)(4).

◦ If partnerships are merged, there may be accountingmethod issues. Merging a cash method and an accrual method partnership can

present problems with cash method accounts receivable. If the surviving partnership is on the accrual method, cash

method accounts receivable income would be charged back underSection 704(c) when collected to the partners of the cash methodpartnership that contributed the cash method accountsreceivable.


Special Problems.

◦ Rev. Rul. 2004-43, 2004-4 C.B. 842 addresses 704(c)(1)(B)and 737(b).

In an “assets-over” construct, the seven year holding period doesnot restart. Treas. Reg. Section 1.704-4(c)(4).

◦ If partnerships are merged, there may be accountingmethod issues. Merging a cash method and an accrual method partnership can

present problems with cash method accounts receivable. If the surviving partnership is on the accrual method, cash

method accounts receivable income would be charged back underSection 704(c) when collected to the partners of the cash methodpartnership that contributed the cash method accountsreceivable.

CrossCross--border Considerationsborder Considerations

◦ Any time a merger or conversion is cross-border (a U.S.entity into a foreign entity or a foreign entity into a U.S.entity) there are additional considerations.

◦ Even if the conversion to a foreign corporation couldotherwise be done tax-free, section 367 would need tobe considered.

◦ Conversion into a foreign pass-through was generallysimpler, under Section 721, but Notice 2015-54 meansthat there are tax consequences. For certain propertywith “built-in gain property” (Section 721(c) property)the “remedial method” is required and “accelerationevents” accelerate gain. Effective for transfersoccurring on or after August 6, 2015 (when the Noticewas issued).


◦ Any time a merger or conversion is cross-border (a U.S.entity into a foreign entity or a foreign entity into a U.S.entity) there are additional considerations.

◦ Even if the conversion to a foreign corporation couldotherwise be done tax-free, section 367 would need tobe considered.

◦ Conversion into a foreign pass-through was generallysimpler, under Section 721, but Notice 2015-54 meansthat there are tax consequences. For certain propertywith “built-in gain property” (Section 721(c) property)the “remedial method” is required and “accelerationevents” accelerate gain. Effective for transfersoccurring on or after August 6, 2015 (when the Noticewas issued).

Partnership Mergersunder Section 708

September 28, 2016

Joseph C. MandarinoSmith, Gambrell & Russell, LLP

Promenade II, Suite 31001230 Peachtree StreetAtlanta, Georgia 30309

www.sgrlaw.com404-815-3685

Partnership MergersTax Treatment vs. State Law

• IRC does not define a partnership merger.

• Some state law regimes permit mergers and conversions.

• Some of transactions that occur under these merger orconversion statutes are not treated as mergers for taxpurposes.

• Some transactions that occur outside the state law mergerand conversion regimes are treated for tax purposes aspartnership mergers.

• IRC does not define a partnership merger.

• Some state law regimes permit mergers and conversions.

• Some of transactions that occur under these merger orconversion statutes are not treated as mergers for taxpurposes.

• Some transactions that occur outside the state law mergerand conversion regimes are treated for tax purposes aspartnership mergers.

4141

Example: State Law Change of Form

• A common state law transaction is to convert one typeof entity into another.

• For example, the partners of a limited partnership maywant to convert that entity into an LLC.

• Similarly, the partners of an entity in one state maywant to convert it into an entity under another state.

• This can be accomplished by merger in certain states,although increasingly these changes can be effectuatedin a single step through a conversion statute.

• A common state law transaction is to convert one typeof entity into another.

• For example, the partners of a limited partnership maywant to convert that entity into an LLC.

• Similarly, the partners of an entity in one state maywant to convert it into an entity under another state.

• This can be accomplished by merger in certain states,although increasingly these changes can be effectuatedin a single step through a conversion statute.

4242

• Because there is only one partnership at thebeginning and end, the IRS takes the view thatthere has been no partnership termination and thepartnership merger rules do not apply. The endingentity retains the TIN of the beginning entity, thereis no truncation of the tax year, etc.

• Moreover, the IRS takes the view that the form oftransaction under state law does not matter (i.e.,merger vs. conversion vs. assets over vs. assets up).Rev. Rul. 95-37.

Example: State Law Change of Form

• Because there is only one partnership at thebeginning and end, the IRS takes the view thatthere has been no partnership termination and thepartnership merger rules do not apply. The endingentity retains the TIN of the beginning entity, thereis no truncation of the tax year, etc.

• Moreover, the IRS takes the view that the form oftransaction under state law does not matter (i.e.,merger vs. conversion vs. assets over vs. assets up).Rev. Rul. 95-37.

4343

Step 1: Starting Position

Y

50%50%

X

44

Oldco(state Z limited partnership with

significant assets)

44

Step 2: Form Newco

Y

50%50%

X

45

Newco(Delaware LLC with no assets)

45

Step 3: State Law Merger

50%

X Y

50%

Y

50%

X

50%

46

Oldco NewcoOldco merges

into Newcounder state law

with Newcosurviving

46

Step 4: Ending Position

Y

50%50%

X

47

Newco(Delaware LLC with assets of

Oldco)

47

Merger Only for State Law

• Oldco and Newco are the same partnership for taxpurposes.

• As noted, tax year does not close and TIN does notchange.

• But, the transfer from an LP to an LLC may havecollateral consequences. For example, theallocation of liabilities to each member maychange.

• Generally, the reduction in liabilities to a member istreated is as a deemed distribution. In certaincircumstances, that can trigger gain.

• Oldco and Newco are the same partnership for taxpurposes.

• As noted, tax year does not close and TIN does notchange.

• But, the transfer from an LP to an LLC may havecollateral consequences. For example, theallocation of liabilities to each member maychange.

• Generally, the reduction in liabilities to a member istreated is as a deemed distribution. In certaincircumstances, that can trigger gain.

4848

Alternative TransactionsThere are at least five ways to accomplish this type of entity-to-entity change in form:

• state law merger of Oldco into Newco

• state law conversion of Oldco into Newco

• X and Y contribution their interests in Oldco to Newco and thenOldco liquidates

• Oldco contributes its assets to Newco in exchange for interestin Newco which Oldco then distributes to X and Y in aliquidating distribution (“Assets Over”)

• Oldco distributes its assets to X and Y who then contribute theassets to Newco (“Assets Up”)

There are at least five ways to accomplish this type of entity-to-entity change in form:


• state law conversion of Oldco into Newco

• X and Y contribution their interests in Oldco to Newco and thenOldco liquidates

• Oldco contributes its assets to Newco in exchange for interestin Newco which Oldco then distributes to X and Y in aliquidating distribution (“Assets Over”)

• Oldco distributes its assets to X and Y who then contribute theassets to Newco (“Assets Up”)

4949

Partnership Mergers and Divisions• From the IRS perspective, all five are equivalent in this context

(entity-to-entity).

• The partnership merger rules are really set up for transactionsin which there are two or more partnerships to start with andat least one is terminated in the transaction.

• The partnership division rules are in some ways analogous tothe partnership merger rules and apply where there is onepartnership to start with and at least two at the end of thetransaction.

• From the IRS perspective, all five are equivalent in this context(entity-to-entity).

• The partnership merger rules are really set up for transactionsin which there are two or more partnerships to start with andat least one is terminated in the transaction.

• The partnership division rules are in some ways analogous tothe partnership merger rules and apply where there is onepartnership to start with and at least two at the end of thetransaction.

5050

Partnership Mergers

• A transaction that is subject to the partnership merger rules willinvolve a combination of distributions and contributions.

• Distributions and contributions are much more likely to be tax-free under the partnership tax rules than are the counterpartsunder the corporate tax rules.

• For this reason, the partnership merger rules are much simplerthan the corporate tax merger rules.

• A transaction that is subject to the partnership merger rules willinvolve a combination of distributions and contributions.

• Distributions and contributions are much more likely to be tax-free under the partnership tax rules than are the counterpartsunder the corporate tax rules.

• For this reason, the partnership merger rules are much simplerthan the corporate tax merger rules.

5151

Partnership Mergers -- Distributions

Notwithstanding this simplicity, there are several exceptions to thetax-free distribution rules that may impact our analysis:

• distributions of cash and marketable securities in excess of basis

• deemed distributions associated with changes in allocations ofliabilities

• a change in ownership of hot assets

• the disguised sale rules

• the mixing bow rules

Notwithstanding this simplicity, there are several exceptions to thetax-free distribution rules that may impact our analysis:

• distributions of cash and marketable securities in excess of basis

• deemed distributions associated with changes in allocations ofliabilities

• a change in ownership of hot assets

• the disguised sale rules

• the mixing bow rules

5252

Section 708• Section 708 contains the only IRC rule for partnership

mergers.

• Primarily, this rule is meant identify the survivor of apartnership merger.

• Section 708 does not address other consequences or evendefine what is a partnership merger.

• Part of this disconnect is that Section 708 predates theenactment of state merger and conversion statutes. Beforethose regimes, partnership “mergers” were effectuated bycontributions and distributions.

• Section 708 contains the only IRC rule for partnershipmergers.

• Primarily, this rule is meant identify the survivor of apartnership merger.

• Section 708 does not address other consequences or evendefine what is a partnership merger.

• Part of this disconnect is that Section 708 predates theenactment of state merger and conversion statutes. Beforethose regimes, partnership “mergers” were effectuated bycontributions and distributions.

5353

General Rule

“In the case of the merger or consolidation of two ormore partnerships, the resulting partnership shall . . . beconsidered the continuation of any merging orconsolidating partnership whose members own aninterest of more than 50 percent in the capital andprofits of the resulting partnership.”

Code § 708(b)(2)(B).

“In the case of the merger or consolidation of two ormore partnerships, the resulting partnership shall . . . beconsidered the continuation of any merging orconsolidating partnership whose members own aninterest of more than 50 percent in the capital andprofits of the resulting partnership.”

Code § 708(b)(2)(B).

5454

Example 2

• Blueco and Redco merge under state law.

• Blueco has two owners, A and B.

• Redco has two owners, C and D.

• Redco is the survivor of the merger.

• Under the merger agreement, C and D each end upwith 30% of the capital and profits of Redco, for atotal of 60%. A and B each end up with 20% of thecapital and profits of Redco, for a total of 40%.

• Blueco and Redco merge under state law.

• Blueco has two owners, A and B.

• Redco has two owners, C and D.

• Redco is the survivor of the merger.

• Under the merger agreement, C and D each end upwith 30% of the capital and profits of Redco, for atotal of 60%. A and B each end up with 20% of thecapital and profits of Redco, for a total of 40%.

5555

Example 2

• The owners of Redco end up with more than 50% ofthe capital and profits of Redco.

• Thus, Redco is the survivor and Blueco is terminated

• Blueco’s tax year ends, files a short year tax return.

• Redco retains its TIN and continues its tax year (notruncation).

• The owners of Redco end up with more than 50% ofthe capital and profits of Redco.

• Thus, Redco is the survivor and Blueco is terminated

• Blueco’s tax year ends, files a short year tax return.

• Redco retains its TIN and continues its tax year (notruncation).

5656

Example 3

• Same facts, but A and B each end up with 30% of the capitaland profits of Redco, for a total of 60%.

• Thus, the owners of Blueco end up with more than 50% of thecapital and profits of Redco.

• Thus, Blueco is the survivor for tax purposes even though itterminates under state law.

• Redco is terminated for tax purposes, its tax year ends, and filesa short year tax return.

• The state law entity that is Redco survives, but now has Blueco’sTIN. Blueco’s tax return will be under the legal name of Redco,but will indicate that it is the continuation of Blueco.

• Same facts, but A and B each end up with 30% of the capitaland profits of Redco, for a total of 60%.

• Thus, the owners of Blueco end up with more than 50% of thecapital and profits of Redco.

• Thus, Blueco is the survivor for tax purposes even though itterminates under state law.

• Redco is terminated for tax purposes, its tax year ends, and filesa short year tax return.

• The state law entity that is Redco survives, but now has Blueco’sTIN. Blueco’s tax return will be under the legal name of Redco,but will indicate that it is the continuation of Blueco.

5757

Example 3

• This result is counterintuitive, but can assist in planning.

• For example, it may be very important that Blueco’s TIN beretained. Blueco could be a medical provider and its TINmay be useful for billing and other purposes.

• Similarly, it may be very important that the state law entitythat is Redco continue in existence even though itterminates for tax purposes. For example, Redco may be aparty to several contracts that cannot be assigned orassumed without the counterparty’s permission.

• This result is counterintuitive, but can assist in planning.

• For example, it may be very important that Blueco’s TIN beretained. Blueco could be a medical provider and its TINmay be useful for billing and other purposes.

• Similarly, it may be very important that the state law entitythat is Redco continue in existence even though itterminates for tax purposes. For example, Redco may be aparty to several contracts that cannot be assigned orassumed without the counterparty’s permission.

5858

Multiple Survivors?• There could be a situation in which owners of two or

more partnerships end up with more than 50% of theresulting partnership.

• This can occur because of cross ownership.

• For example, if A and C in the prior examples were thesame individual, both sets of partners would qualify asowning more than 50% of Redco at the end of thetransaction.

• In that case, the regulations provide a tie-breaker: thesurviving partnership is the one that had that largest netvalue of assets.

• There could be a situation in which owners of two ormore partnerships end up with more than 50% of theresulting partnership.

• This can occur because of cross ownership.

• For example, if A and C in the prior examples were thesame individual, both sets of partners would qualify asowning more than 50% of Redco at the end of thetransaction.

• In that case, the regulations provide a tie-breaker: thesurviving partnership is the one that had that largest netvalue of assets.

5959

No Survivors?• There could also be a situation in which no owners of any of

the combining partnerships end up with more than 50% ofthe resulting partnership.

• This can occur if there are more at least three combiningpartnerships.

• For example, if in the prior examples E and F ownedGreenco, and Greenco also combined into Redco, and eachof A, B, C, D, E and F received 16.6% of Redco after thecombination, then no combining partnership’s owners wouldend up with more than 50% of the resulting partnership.

• In that case, all the merging partnerships are deemed toterminate and there is no survivor.

• Thus, all three partnerships would have short year tax turns,and the state law entity that is Redco would need to obtain anew TIN.

• There could also be a situation in which no owners of any ofthe combining partnerships end up with more than 50% ofthe resulting partnership.

• This can occur if there are more at least three combiningpartnerships.

• For example, if in the prior examples E and F ownedGreenco, and Greenco also combined into Redco, and eachof A, B, C, D, E and F received 16.6% of Redco after thecombination, then no combining partnership’s owners wouldend up with more than 50% of the resulting partnership.

• In that case, all the merging partnerships are deemed toterminate and there is no survivor.

• Thus, all three partnerships would have short year tax turns,and the state law entity that is Redco would need to obtain anew TIN.

6060

Form of Transaction• The 708 rules contemplate only two forms of mergers:

– The assets over transaction is the default form.

– The assets up transaction is the one exception.

• Thus, unless the transaction is actually structured as anassets up merger, the transaction will be treated as anassets over merger regardless of how it is structured forstate law purposes.

• The 708 rules contemplate only two forms of mergers:

– The assets over transaction is the default form.

– The assets up transaction is the one exception.

• Thus, unless the transaction is actually structured as anassets up merger, the transaction will be treated as anassets over merger regardless of how it is structured forstate law purposes.

6161

Assets Over – Tax Treatment• In an assets up transaction, the steps are as follows:

– The terminated partnership contributes all of its assetsand liabilities to the surviving partnership in exchange forinterests in that partnership

– Immediately after, the terminated partnership distributesthese interests to its owners in a liquidating distribution

• Note that the identification of the terminated partnershipand the surviving partnership are based on the 708 rules –thus, a partnership that actually terminates under state lawcould be the survivor and vice versa.

• In an assets up transaction, the steps are as follows:

– The terminated partnership contributes all of its assetsand liabilities to the surviving partnership in exchange forinterests in that partnership

– Immediately after, the terminated partnership distributesthese interests to its owners in a liquidating distribution

• Note that the identification of the terminated partnershipand the surviving partnership are based on the 708 rules –thus, a partnership that actually terminates under state lawcould be the survivor and vice versa.

6262

Assets Up Form• In an assets up transaction, the steps are as follows:

– The terminated partnership distributes all of itsassets and liabilities to its owners in a liquidatingdistribution

– Immediately after, the owners of the terminatedpartnership contributes these assets and liabilities tothe surviving partnership.

• Note that there may be a benefit to this form if theowners of the terminated partnership have a higheroutside basis than inside basis.

• Again, a partnership that actually terminates understate law could be the survivor and vice versa.

• In an assets up transaction, the steps are as follows:

– The terminated partnership distributes all of itsassets and liabilities to its owners in a liquidatingdistribution

– Immediately after, the owners of the terminatedpartnership contributes these assets and liabilities tothe surviving partnership.

• Note that there may be a benefit to this form if theowners of the terminated partnership have a higheroutside basis than inside basis.

• Again, a partnership that actually terminates understate law could be the survivor and vice versa.

6363

Form Confusion• The definition of the assets up transaction depends on

the identification of the terminated and survivingpartnerships.

• Sometimes the parties may intend to structure anassets up transaction but the terminated and survivingpartnerships are not identical to the state lawcounterparts.

• The definition of the assets up transaction depends onthe identification of the terminated and survivingpartnerships.

• Sometimes the parties may intend to structure anassets up transaction but the terminated and survivingpartnerships are not identical to the state lawcounterparts.

6464

Form Confusion• For example, assume a combination of Blueco and

Redco as an assets up transaction.

• Assume Blueco distributes its assets to A and B, and Aand B end up with more than 50% of Redco.

• Thus, Redco is the terminated partnership.

• As a result, the distribution from Blueco to A and B isnot a distribution from the terminated partnership andtis transaction would instead be treated as an assetsover transaction for tax purposes.

• This may be undercut the intent of the parties.

• For example, assume a combination of Blueco andRedco as an assets up transaction.

• Assume Blueco distributes its assets to A and B, and Aand B end up with more than 50% of Redco.

• Thus, Redco is the terminated partnership.

• As a result, the distribution from Blueco to A and B isnot a distribution from the terminated partnership andtis transaction would instead be treated as an assetsover transaction for tax purposes.

• This may be undercut the intent of the parties.

6565

Equivalent Transactions

W X ZY

66

Oldco Newco

66

Seven Equivalent Transactions per IRS• state law merger of Oldco into Newco

• state law merger of Newco into Oldco

• contribution of interests in Oldco to Newco

• contribution of interests in Newco to Oldco

• contribution of assets of Oldco to Newco for Newco interests that aredistributed to Oldco’s owners

• contribution of assets of Newco to Oldco for Oldco interests that aredistributed to Newco’s owners

• distribution of assets to of survivor to survivor’s owners with immediatecontribution to terminating partnership (“failed” assets up)

All of these are treated as assets over transactions.


• state law merger of Newco into Oldco

• contribution of interests in Oldco to Newco

• contribution of interests in Newco to Oldco

• contribution of assets of Oldco to Newco for Newco interests that aredistributed to Oldco’s owners

• contribution of assets of Newco to Oldco for Oldco interests that aredistributed to Newco’s owners

• distribution of assets to of survivor to survivor’s owners with immediatecontribution to terminating partnership (“failed” assets up)

All of these are treated as assets over transactions.

6767

Assets Over – Partial Sale Variation

• Under certain circumstances, partners of the terminatedpartnership in an assets over transaction can be treated as sellingtheir interests to the surviving partnership.

• This rule helps the other partners of the terminated partnershipavoid having to recognize taxable gain.

• This rule is often coupled with a cash distribution to the sellingpartners.

• Under certain circumstances, partners of the terminatedpartnership in an assets over transaction can be treated as sellingtheir interests to the surviving partnership.

• This rule helps the other partners of the terminated partnershipavoid having to recognize taxable gain.

• This rule is often coupled with a cash distribution to the sellingpartners.

6868

Disguised Sale Rules

• A contribution to a partnership that otherwise qualifies astax-free can be taxable if it violates the disguised sale rules.

• The disguised sale rules apply to contributions of propertyor cash by a partner to a partnership that can be tied to atransfer of property or cash by the partnership to the samepartner.

• Note that these rules will also convert an otherwise tax-freedistribution of property by the partnership to a memberinto a taxable event.

• A contribution to a partnership that otherwise qualifies astax-free can be taxable if it violates the disguised sale rules.

• The disguised sale rules apply to contributions of propertyor cash by a partner to a partnership that can be tied to atransfer of property or cash by the partnership to the samepartner.

• Note that these rules will also convert an otherwise tax-freedistribution of property by the partnership to a memberinto a taxable event.

69

Disguised Sale Rules• Three conditions must be met:

– there is a transfer of cash or property by a partner to apartnership;

– there is a transfer of cash or property by thepartnership to the same partner; and

– the transfers, when viewed together, are properlycharacterized as a sale or exchange of property.

• Three conditions must be met:

– there is a transfer of cash or property by a partner to apartnership;

– there is a transfer of cash or property by thepartnership to the same partner; and

– the transfers, when viewed together, are properlycharacterized as a sale or exchange of property.

70

Disguised Sale Rules• The last factor is the most difficult part of the analysis.

Generally, this is a facts-and-circumstances determination.However, the applicable regulations provide an importantpresumption:

– A distribution that occurs within two years of aproperty contribution is deemed to result in adisguised sale.

• The last factor is the most difficult part of the analysis.Generally, this is a facts-and-circumstances determination.However, the applicable regulations provide an importantpresumption:

– A distribution that occurs within two years of aproperty contribution is deemed to result in adisguised sale.

71

Disguised Sale Rules - Example• X and Y form a Newco LLC by contributing a variety of assets. Later, at

time when Newco is worth $1 million, Z contributes $500,000 for a one-third interest. On the next day, Newco distributes assets to Z worth$250,000.

• Here, one member – Z – contributes cash or property (i.e., $500,000 incash) and there appears to be a related transfer of cash or property backto Z (i.e., assets worth $250,000).

• This may be treated as a disguised sale. Accordingly, Newco will berequired to recognize gain (if any) on the transfer of assets worth$250,000 to Z. (Such gain would likely be allocated to X and Y under the704(c) rules as it would be attributable to appreciation prior to the timeof Z’s entry into the LLC.)

• X and Y form a Newco LLC by contributing a variety of assets. Later, attime when Newco is worth $1 million, Z contributes $500,000 for a one-third interest. On the next day, Newco distributes assets to Z worth$250,000.

• Here, one member – Z – contributes cash or property (i.e., $500,000 incash) and there appears to be a related transfer of cash or property backto Z (i.e., assets worth $250,000).

• This may be treated as a disguised sale. Accordingly, Newco will berequired to recognize gain (if any) on the transfer of assets worth$250,000 to Z. (Such gain would likely be allocated to X and Y under the704(c) rules as it would be attributable to appreciation prior to the timeof Z’s entry into the LLC.)

72

Disguised Sales of Partnership Interest

• The statute also provides that a distribution of partnershipinterests could be subject to the disguised sale rules.

• The IRS initially proposed regulations on disguised sales ofpartnership interests in 2004, where they were met withalmost universal criticism.

• The IRS withdrew the regs and advised taxpayers to look tostatutory language, case law and legislative history.

• The statute contains little guidance, the cases are all over themap, and the legislative history show some willingness tooverrule the case law, but delegated this to regulations.

• The statute also provides that a distribution of partnershipinterests could be subject to the disguised sale rules.

• The IRS initially proposed regulations on disguised sales ofpartnership interests in 2004, where they were met withalmost universal criticism.

• The IRS withdrew the regs and advised taxpayers to look tostatutory language, case law and legislative history.

• The statute contains little guidance, the cases are all over themap, and the legislative history show some willingness tooverrule the case law, but delegated this to regulations.

73

73

Mixing Bowl Rule 1:Distribution of Property to Different

Partner within 7 Years• Specific fact pattern:

– if one party contributes property to the partnership;

– the property is distributed to a different partner; and

– the distribution occurs within 7 years of the contribution

• then the distribution is treated as a deemed sale of theproperty and the contributing partner is required torecognize gain.

• Specific fact pattern:

– if one party contributes property to the partnership;

– the property is distributed to a different partner; and


• then the distribution is treated as a deemed sale of theproperty and the contributing partner is required torecognize gain.

74

• The amount of gain is the amount that would have beenallocated to the partner by virtue of the 704(c) rules (i.e.,the difference between the FMV of the property and its taxbasis at the time of contribution).

• Note that the contributing partner is only required torecognize its 704(c) amount, not the full amount of theinherent gain.

Distribution of Property to DifferentPartner within 7 Years

• The amount of gain is the amount that would have beenallocated to the partner by virtue of the 704(c) rules (i.e.,the difference between the FMV of the property and its taxbasis at the time of contribution).

• Note that the contributing partner is only required torecognize its 704(c) amount, not the full amount of theinherent gain.

75

Mixing Bowl Rule 2:Distribution of Property to Same Partner

within 7 Years

• §737 rules provides that:

– if a partner contributes appreciated property to apartnership;

– other property is distributed to the same partner; and


• then the contributing partner is required to recognize gain.

• §737 rules provides that:

– if a partner contributes appreciated property to apartnership;

– other property is distributed to the same partner; and


• then the contributing partner is required to recognize gain.

76

Mixing Bowl Rules and Assets Up

• Note that because of its form, the mixing bowl rules mayapply to a combination that is treated as an assets uptransaction for 708 purposes.

• This is not the case for a combination treated as an assetsover transaction.

• Note that because of its form, the mixing bowl rules mayapply to a combination that is treated as an assets uptransaction for 708 purposes.

• This is not the case for a combination treated as an assetsover transaction.

77

Investment Credit Recaptureand Assets Up Form

• An assets over transaction generally will not trigger anyinvestment tax credit recapture.

• In contrast, in the assets up form, the investment creditrecapture rules will be triggered.

78

Partnership Divisions

• Section 708 also provides guidance on so-called partnershipdivisions. Like partnership mergers, there is no definition ofa partnership division.

• In general, it is a transaction in which part of the assets ofan existing partnership are transferred into a newpartnership, yielding two or more partnerships after thetransaction.

• So like the approach to partnership mergers, partnershipdivisions generally involve contributions and distributions.

• The rules under 708 generally aimed at determining if thereis a continuing partnership.

• Section 708 also provides guidance on so-called partnershipdivisions. Like partnership mergers, there is no definition ofa partnership division.

• In general, it is a transaction in which part of the assets ofan existing partnership are transferred into a newpartnership, yielding two or more partnerships after thetransaction.

• So like the approach to partnership mergers, partnershipdivisions generally involve contributions and distributions.

• The rules under 708 generally aimed at determining if thereis a continuing partnership.

79

Partnership Divisions

• Because 708 only governs which entity is deemed to be thesurvivor of a division, it does not address otherconsequences.

• So, as with partnership mergers, the contributions anddistributions that effectuate a division are givenindependent significance.

• Thus, to the extent the contributions and distributions aretax-free, the division will be tax-free.

• Because 708 only governs which entity is deemed to be thesurvivor of a division, it does not address otherconsequences.

• So, as with partnership mergers, the contributions anddistributions that effectuate a division are givenindependent significance.

• Thus, to the extent the contributions and distributions aretax-free, the division will be tax-free.

80

Survivor – General Rule

“In the case of a division of a partnership into two or morepartnerships, the resulting partnerships (other than anyresulting partnership the members of which had an interest of50 percent or less in the capital and profits of the priorpartnership) shall, for purposes of this section, be considered acontinuation of the prior partnership.”

Code § 708(b)(2)(B).

“In the case of a division of a partnership into two or morepartnerships, the resulting partnerships (other than anyresulting partnership the members of which had an interest of50 percent or less in the capital and profits of the priorpartnership) shall, for purposes of this section, be considered acontinuation of the prior partnership.”

Code § 708(b)(2)(B).

81

Survivor Rules• More than one partnership can be treated as a continuation

of the original partnership.

• In that case, each is bound by the partnership elections ofthe original partnership and the tax returns of each muststate that it is a continuation of the original partnership.

• But, only one of these continuing partnerships takes the TINof the original partnership and is deemed to retain theassets that it holds at the end of the division (rather thanreceiving assets).

• This partnership is called the “divided partnership”

• More than one partnership can be treated as a continuationof the original partnership.

• In that case, each is bound by the partnership elections ofthe original partnership and the tax returns of each muststate that it is a continuation of the original partnership.

• But, only one of these continuing partnerships takes the TINof the original partnership and is deemed to retain theassets that it holds at the end of the division (rather thanreceiving assets).

• This partnership is called the “divided partnership”

82

Survivor Rules• Any partnership that does not constitute a continuation of

the original partnership is treated as a new partnership.

• If no resulting partnership is treated as a continuation of theoriginal partnership, then the original partnership is treatedas terminating in the division transaction.

• If a partner of the original partnership does not end up as apartner of the continued partnership, her interest is treatedas liquidated in the division transaction.

• Any partnership that does not constitute a continuation ofthe original partnership is treated as a new partnership.

• If no resulting partnership is treated as a continuation of theoriginal partnership, then the original partnership is treatedas terminating in the division transaction.

• If a partner of the original partnership does not end up as apartner of the continued partnership, her interest is treatedas liquidated in the division transaction.

83

Division Definitions• “Prior Partnership” – the state law entity that existed prior

to the division – there will be only one of these• “Resulting Partnership” – any state law entity that exists

after the division and has at least two partners who werepartners of the Prior Partnership – often two or more ofthese

• “Divided Partnership” – the partnership that is treated (fortax purposes) as transferring assets and liabilities to theRecipient Partnership in the division transaction -- there willbe only one of these

• “Recipient Partnership” – the partnership that is treated (fortax purposes) as receiving assets and liabilities from theDivided Partnership in the division transaction – at least oneof these

• “Prior Partnership” – the state law entity that existed priorto the division – there will be only one of these

• “Resulting Partnership” – any state law entity that existsafter the division and has at least two partners who werepartners of the Prior Partnership – often two or more ofthese

• “Divided Partnership” – the partnership that is treated (fortax purposes) as transferring assets and liabilities to theRecipient Partnership in the division transaction -- there willbe only one of these

• “Recipient Partnership” – the partnership that is treated (fortax purposes) as receiving assets and liabilities from theDivided Partnership in the division transaction – at least oneof these

84

Form of DivisionAs with the partnership merger rules, the division rules contemplate onlytwo types of divisions:

• Assets Over

– An existing partnership transfers some portion of its assets andliabilities to a new partnership in exchange for ownership of thatpartnership

– The existing partnership then distributes interests in the newpartnership to some or all of the existing partnership's owners

• Assets Up

– An existing partnership distributes some or all of its assets andliabilities to some or all of its owners

– The receiving owners then contribute the assets and liabilities toone or more new partnerships

As with the partnership merger rules, the division rules contemplate onlytwo types of divisions:

• Assets Over

– An existing partnership transfers some portion of its assets andliabilities to a new partnership in exchange for ownership of thatpartnership

– The existing partnership then distributes interests in the newpartnership to some or all of the existing partnership's owners

• Assets Up

– An existing partnership distributes some or all of its assets andliabilities to some or all of its owners

– The receiving owners then contribute the assets and liabilities toone or more new partnerships

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Form of Division• Unless the form of the transaction is an assets up

transaction, all other formats are treated as assets overdivisions for tax purposes.

• As with merger counterpart, there can be some confusion asto which type of transaction has occurred.

• Once the analysis settles on a type of transaction, then theissues raised by the contributions and distributions withinthat format have to be addressed.

• Unless the form of the transaction is an assets uptransaction, all other formats are treated as assets overdivisions for tax purposes.

• As with merger counterpart, there can be some confusion asto which type of transaction has occurred.

• Once the analysis settles on a type of transaction, then theissues raised by the contributions and distributions withinthat format have to be addressed.

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structuring section 708 partnership mergers absent irs...

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