Converting a partnership to a corporation.The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. recently issued Rev. Rul. 2004-59, holding that the incorporation of a partnership under a state law formless form·less
1. Having no definite form; shapeless. See Synonyms at shapeless.
2. Lacking order.
3. Having no material existence. conversion statute will be treated in the same manner as a partnership that makes a "check-the-box" election to be treated as a corporation for tax purposes. Thus, the following will be deemed to occur: (1) the partnership contributes its assets and liabilities to a new corporation in exchange for stock; and (2) the partnership immediately liquidates, distributing that stock to the partners.
Rev. Rul. 2004-59 provides that an earlier ruling, Rev. Rul. 84-111, does not apply to a formless conversion of a partnership. In the prior ruling, the IRS described three different methods of incorporating a partnership: (l) the assets-over method (as used in Rev. Rul. 2004-59); (2) the distribution of the partnership's assets to the partners in liquidation The collection of assets belonging to a debtor to be applied to the discharge of his or her outstanding debts.
A type of proceeding pursuant to federal Bankruptcy of the partnership, followed by the transfer of those assets by the partners to the corporation; and (3) the transfer by the partners of their partnership interests to the corporation. Rev. Rul. 84-111 held that the form of each of the three methods would he respected, then described the different tax consequences associated with each.
Although a formless conversion may be the simplest method of con vetting vet 1 Informal
v. vet·ted, vet·ting, vets
1. To subject to veterinary evaluation, examination, medication, or surgery.
2. a partnership into a corporation, it may not be the most tax effective method. As illustrated below, one of the other methods described in Rev. Rul. 84-111 may result in greater tax savings.
Example 1: A and B are partners in AB partnership. AB's assets consist of machinery and equipment with a $100 fair market value (FMV FMV - full-motion video ), a $120 original cost and an $80 inside tax basis to the partnership. AB has no liabilities. A and B have a $100 collective outside basis in their partnership interests. They seek cash and bring in C, an outside venture capital fund, which wishes to invest only in a corporation. C will contribute $20 cash for new company (N) stock, coupled with A and B contributing the AB property to N for N stock with an $80 FMV and $20 cash.
The partners use their state's formless conversion law. AB will be deemed to transfer its assets to N for $80 of N stock, plus $20 cash. Under Sec. 351 (b), AB's $20 realized gain Realized Gain
A gain resulting from selling an asset at a price higher than the original purchase price.
There may be tax consequences for a realized profit. is recognized to the extent of the $20 cash received in the exchange. On the deemed distribution of the N stock to the AB partners, AB terminates under Sec. 708(b)(1)(A). Under Sec. 358(a)(1), in a transaction to which Sec. 351 applies, AB's basis in the N stock is the same as that of the property exchanged ($80), decreased by the cash received ($20) and increased by the gain recognized ($20). Under Sec. 732(b), the basis in the partners' hands of the property distributed in the AB liquidation is A's and B's collective outside basis ($100), increased by the $20 gain, and reduced by the $20 received. As a result, a gain of $20 is reported when AB converts to a corporation in an assets-over transaction using a state formless conversion law, and the partners take a $100 collective tax basis in the N stock.
Example 2: The facts are the same as in Example 1, except AB does not make a formless conversion, but instead takes the steps described in the third situation in Rev. Rul. 84-111 to convert to a corporation (i.e., A and B transfer their partnership interests to N in exchange for $80 of N stock and $20 cash). The partners realize no gain or loss on transferring their partnership interests to N in exchange for its stock and cash, inasmuch as in·as·much as
1. Because of the fact that; since.
2. To the extent that; insofar as.
1. since; because
2. their aggregate outside basis is $100 and the combined FMV of stuck and cash received is $100. Under Sec. 358(a), the partners' basis in the N stock received in the exchange for their partnership interests equals the basis of those interests ($100), reduced by the cash received ($20).As a result, they recognize no gain on receiving $20 cash when AB converts to a corporation by a transfer of A and B's interests. In addition, their resulting basis in the N stock is $80.
Compared to the formless conversion alternative, the partners do not recognize an immediate $20 gain. However, they will be subject to a $20 greater gain or lesser loss on a future sale of their stock, inasmuch as their basis in the N stock is $80, not $100, as it would be after a form less conversion.
Choosing between a formless conversion and another method described in Rev. Rul. 84-111 may have state implications, too. A taxpayer with facts similar to those above, in which the partnership recognizes gain on the receipt of boot in an assets-over formless conversion under Rev. Rul. 2004-59, would recognize "business income" in the amount of the gain apportionable Adj. 1. apportionable - capable of being distributed
distributive - serving to distribute or allot or disperse to the states within which it does business. By treating the conversion as a transfer of the partners' interests in exchange for stock, not only might immediate gain be avoided as illustrated in Example 2, but any recognized gain Recognized Gain
The amount of gain reported for income tax purposes.
You can defer recognizing some gains until the following year(s).
See also: Capital Gain, Capital Loss, Deferred Income Tax, Drought Sale, Exempt Income, Exemption, Gain, Recognized Loss might also be sourced only to each partner's state of commercial domicile domicile (dŏm`əsīl'), one's legal residence. This may or may not be the place where one actually resides at any one time. The domicile is the permanent home to which one is presumed to have the intention of returning whenever the purpose . In such a case, a transfer of interests would be beneficial when the state income tax rate in a partner's state of residency A duration of stay required by state and local laws that entitles a person to the legal protection and benefits provided by applicable statutes.
States have required state residency for a variety of rights, including the right to vote, the right to run for public office, the is less than the average rate in states in which the partnership does business. FROM MICHAEL R. SCHUTH, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , MST See micro systems technology. , OAK BROOK, IL