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Megan C
Megan C, Certified Public Accountant (CPA)
Category: Social Security
Satisfied Customers: 14030
Experience:  Licensed CPA, CMA, CFE, CGMA M.Accy Also Teach Accounting courses at Master's Level
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Hello Megan, My basic question is whether an LLC to Corporation

Resolved Question:

Hello Megan,

My basic question is whether an LLC to Corporation conversion can be effected midyear (after the LLC has some profits for the year) without the LLC members realizing substantial tax liabilities, or being double-taxed on profits up to the date of conversion.

This question pertains to a conversion of a MD LLC to a DE Corporation. It was a statutory (sec.265) conversion. My understanding is that as part of the conversion the LLC transferred its assets, which consist of a mostly cash and one or two contracts, to the corporation. The corporation issues stock to the LLC which is apportioned among its members.

While this type of conversion is always talked about as if it is a 'tax free event' it really doesn't seem that way for the LLC members in the scenario below.

This conversion occurred mid-year and the LLC had some profits up to that point. If (according to my reading of the statute) the LLC does not take a loss (gain) on the asset transferred to(from) to the corporation, then we have two problems.

1) For any profits in the present year (as of the conversion date) the LLC members will have taxable gains on their K-1 for money they never received, and is now locked up inside the corporation. In the statutory conversion the LLC is assumed to liquidate after the conversion. (The assumed liquidation is apparent from the description of the typical "assets over" treatment by the IRS. However, Sec.265(g) contradicts this at the state level by saying no liquidation is assumed) This is only a problem insofar as these profits exceeds their previous year's end-of-year basis (since the members will realize a capital loss which will offset some of the current year profits). Is this correct?

2) If the corporation uses any cash it receives from the LLC, (say to do payroll between the conversion date and end-of-year), then this money is going to be double (triple?) taxed. This is a because the members get taxed on the profits from their K-1, but then the corporation can't pay that same the money out to its shareholders (same people) without getting taxed again at the corporate level, (through payroll for instance). The corporation is also going to wind up with a big loss on its books for the present year, since its paying out money it received in the conversion that isn’t income. Is this correct?

Is there a way to prevent the LLC members from having a substantial tax liability due to the conversion?
Submitted: 10 months ago.
Category: Social Security
Expert:  Megan C replied 10 months ago.

Megan C :

Hello, thanks for your question and thanks for requesting me

Megan C :

How are you today?

Megan C :

The transfer of assets is tax free in and of itself, but the LLC members will still be taxed on the profits that were earned by the LLC prior to the conversion.

Megan C :

This is not an additional tax, but it is true that they will owe this tax even if no funds have been dispersed to them.

Megan C :

There's no way around this.

Customer:

Hi Megan

Megan C :

Also, the corporation will not be double taxed on the cash. Tax was paid on the profits when earned. The Corp does not pay tax on the receipt of cash

Customer:

they cant get that money out of the corporation without being taxed either, correct?

Megan C :

but, this money is taxed again at the personal level when paid out as salary or dividends

Customer:

ok

Megan C :

No, if you take a dividend from the corp, it is taxed

Customer:

that sucks

Customer:

OK, thank you for your quick reply

Megan C :

Yes, any way you pull money from a corp is taxed...dividends, salary, etc

Megan C :

If they want the cash, they should take it before the conversion

Customer:

regarding the liquidation

Megan C :

ok

Customer:

right, so we should ideally pay out all the cash before conversion

Customer:

profits rather

Megan C :

Yes, if you do not want to be taxed on that money again, yes.

Customer:

do we need ot take out all prfoits, or only those profits less the members basis?

Megan C :

only the profits less the the members basis would work

Customer:

technically, this conversion ahpopened in april

Customer:

since state law does not recognise that the LLC needs to be liquidated immediately

Customer:

can we pay out that cash now as a distribution from the LLC?

Megan C :

Okay if the conversion already took place there's nothing that you can do

Megan C :

The funds are now in the corp, correct?

Customer:

well the checking account is shared

Customer:

unless the converison law say that ALL cash has to be transferred

Customer:

we could say its still in the LLC

Megan C :

No, the law of the conversion would apply that the funds are now in the corporation

Customer:

ok

Customer:

thanks

Megan C :

You're welcome

Megan C :

Is there anything else that I can assist you with today?

Customer:

Not right now, but thanks for your quick reply

Customer:

and we may come back in the future

Megan C :

Okay please do

Megan C :

Before you leave, please rate positive so that I may receive credit for assisting today

Customer:

ok looking to see where i do that

Megan C :

There's a feature along the bottom of your screen that has either 5 stars or 5 smiley faces

Customer:

ok good done

Megan C :

3-5 stars or smileys gives me full credit

Megan C, Certified Public Accountant (CPA)
Category: Social Security
Satisfied Customers: 14030
Experience: Licensed CPA, CMA, CFE, CGMA M.Accy Also Teach Accounting courses at Master's Level
Megan C and other Social Security Specialists are ready to help you

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