Today, limited liability companies can be found everywhere. With their flexible management structure, LLCs have become a common way to own and operate a business. Professionals (doctors, lawyers, accountants, and engineers), as well as software and computer-based companies and a wide array of other small businesses, are increasingly using this form of organization. LLCs offer owners—generally known as members—the liability protection of a corporation and the tax structure of a partnership.
As LLCs increase in popularity, CPAs confronted with complex tax issues, particularly when ownership of the LLC changes. The IRS issued revenue rulings 99-5 and 99-6 to address issues surrounding the conversion of a single-member LLC to a multiple-member LLC and the conversion of a multiple-member LLC to a single owner entity. This article explains the rulings and discusses proper accounting procedures for the transactions they highlight. Also, it supplements the examples in the rulings and offers some useful planning tips for CPAs.
EXECUTIVE SUMMARY
- THE IRS ISSUED REVENUE RULINGS 99-5 AND 99-6 to address issues related to the conversion of single-member LLCs to multi-member LLCs and the conversion of multi-member LLCs to a single-owner entity.
- REVENUE RULING 99-5 PROVIDES CPAs WITH GUIDANCE on proper accounting when a single-member LLC converts to a multi-member LLC. The ruling examines the transaction from two perspectives: the sole owner sells a half interest to someone else or the new owner contributes property in exchange for a half interest.
- THE BEST METHOD FOR BRINGING A NEW OWNER into the business depends on the selling owner’s intent. If the seller wants to increase his or her personal cash flow, selling a half interest may be the best approach. If the seller wants a capital infusion for the business, allowing someone to contribute property in exchange for a half interest will be preferable.
- REVENUE RULING 99-6 DEALS WITH INSTANCES WHEN a multi-owner LLC is converted to a single-owner entity. The ruling covers the transaction from two approaches: one LLC member sells his or her full interest to another member or all LLC members sells their full interests to a nonmember.
- THE BEST OPTION UNDER REVENUE RULING 99-6 ALSO depends on the seller’s motivation. Owners will often use the first approach when they have a contractual agreement to sell their interests to each other, such as in the event of death, divorce or retirement. The second approach is best when all owners want to leave the business.
SINGLE-MEMBER TO MULTI-MEMBER LLC
Revenue ruling 99-5 provides guidance on proper accounting procedures when a single-member LLC converts to a multiple-member LLC. The ruling addresses the conversion issue from two perspectives:
- A sole member sells a half interest to another person.
- The new member contributes property, including cash, to the LLC in exchange for a half interest instead of buying part of an existing member’s ownership interest.
Planning Tips
- Carefully identify and track assets with multiple holding periods along with the holding periods of other
assets.
- Keep in mind that when advising clients on LLC conversions, the process generally has two distinct phases: (1) the type of conversion to undertake and its consequences and (2) post-conversion transactions when the LLC or its members may sell assets acquired during the conversion.
- When recommending a preferred method of LLC conversion to clients, remember that the member’s intent or preexisting membership agreements may determine the conversion method.
- Develop a clear understanding of LLC conversion methods—and the resulting tax consequences for all parties—because over time a CPA may represent a different party in each conversion.
- Remember that conversion may invoke the three-tier basis allocation process outlined in IRC section 732.
MULTI-MEMBER TO SINGLE-MEMBER LLC
Revenue ruling 99-6 provides guidance when a multiple-member LLC is converted to a single-owner entity for tax purposes. The ruling also addresses the conversion issue from two perspectives.
- One LLC member sells his or her full ownership interest to another member, making the transferee the sole owner.
- LLC members sell their full ownership interests to a nonmember.
THE PREFERRED BUSINESS ENTITY
The importance of revenue rulings 99-5 and 99-6 will increase as the LLC continues to become America’s preferred business entity. While the LLC offers many tax and nontax advantages, it also offers a great disadvantage: The application of subchapter K and its myriad intricate partnership taxation rules and procedures. Unfortunately, as LLCs become more prevalent, CPAs and their clients will encounter complex partnership issues, such as those in revenue rulings 99-5 and 99-6, more frequently. Proper planning requires a strong understanding of the technical interplay between the sellers’ desire and the various partnership provisions in the IRC. The inability to resolve issues such as split holding periods, gain or loss recognition and basis will leave some taxpayers with undesirable present and future tax consequences.
Flex Tax and Consulting Group, is a comprehensive fee-based service that will help site visitors form an LLC in.the U.S. The site includes free access to a wealth of information, including a glossary of terms, the answers to frequently asked LLC questions and detailed state-by-state incorporation procedures.
