The limited liability company (LLC) has become an important component of federal and state tax planning for many U.S. companies. Converting a state law corporation to an LLC may cause losses that are locked up in the corporation to become available as an offset to other income once the LLC is classified as a disregarded entity for federal tax purposes. Disregarded entity status may also simplify the federal tax filings of the ultimate owner.
Most companies that convert a corporation to an LLC want the LLC to retain the historic employer identification number (EIN) of the corporation and may assume that the EIN carries over automatically to the LLC. In fact, the IRS will reassign the historic EIN of a corporation to a successor LLC only in certain situations.
A company that is considering converting a corporate subsidiary to an LLC should determine whether the EIN will be reassigned to the LLC before filing any state conversion document. If the historic EIN of the predecessor corporation has been used on federal and state employment tax returns and to obtain state licenses and registrations, the economic cost of having to obtain a new EIN for the LLC could be substantial. For example, a company’s payroll service may have to implement new databases for entities with new EINs, which can be time consuming and costly. Further, for an entity that receives state Medicare and Medicaid reimbursements, any interruption of an EIN can cause significant delays in receiving these reimbursements.
A wholly owned LLC that is classified as a disregarded entity avoids an entity-level income tax but is treated as a corporation for purposes of employment tax and excise tax filings. Regs. Secs. 301.7701-2(c)(2)(iv) and (v) provide that a single-member LLC classified as a disregarded entity is not disregarded for purposes of such filings. Thus, if an LLC has employees or is liable for excise tax, the LLC must have its own EIN for filing Forms 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, 941, Employer’s Quarterly Federal Tax Return, and 720, Quarterly Federal Excise Tax Return.
A state law corporation that has a history of filing federal tax payments and returns under a specific EIN most likely will want to retain that EIN when converting to an LLC, regardless of whether the LLC is classified as a disregarded entity, a partnership, or an association taxable as a corporation. The check-the-box regulations found at Regs. Secs. 301.7701-1 through -3 allow an eligible business entity to elect its federal tax classification. When a state law corporation converts to an LLC, it is converting from a per se corporation, which is ineligible to be classified as anything other than a corporation, to an entity that may elect its federal tax classification or do nothing and default to the classification prescribed in Regs. Sec. 301.7701-3(b)(1).
Converting a State Law Corporation to an LLC
An LLC is formed under state law, and the IRS looks to what has happened under state law in determining whether it may reassign the historic EIN of a corporation to a newly formed LLC. The IRS draws a distinction between a state law conversion of a corporation to an LLC and a state law merger of a corporation with an LLC with the LLC surviving.
A conversion is a mere change in the legal status of a business, while a merger is the joining of two separate legal entities. The IRS ordinarily will reassign the EIN of a corporation to a successor LLC if the corporation converted to an LLC under state law, but the steps involved vary based on local law. A tax adviser should not assume that the state filings are the same, for example, for a Delaware conversion and a California conversion. Furthermore, in those states that do not have a conversion statute, converting a corporation to an LLC is not an option.
If a state does not have a conversion statute and a company wants to reorganize a corporation organized under that state’s law to a single-member LLC classified as a disregarded entity, the company may:
- Form a wholly owned LLC under the state’s LLC statute, file Form 8832, Entity Classification Election, to have the LLC classified as a corporation effective as of the date of formation (an initial election), and merge the corporation with the LLC in a reorganization under Sec. 368(a)(1)(F) with the LLC as survivor. Rev. Rul. 73-526 holds that the EIN of a predecessor corporation will be reassigned to a successor corporation in an F reorganization—i.e., a reorganization that is a “mere change in identity, form, or place of organization of one corporation, however effected.” The LLC may then file a second Form 8832 to change its federal tax classification to disregarded entity, after which the LLC may not change its federal tax classification again for 60 months (see Regs. Sec. 301.7701-3(c)(1)(iv)).
- Merge the corporation with a corporation formed under the laws of a different state that has a conversion statute. The merger will qualify as a reorganization under Sec. 368(a)(1)(F), and the EIN will be assigned to the surviving entity under Rev. Rul. 73-526. The surviving corporation can then convert under the law of the new state in which the surviving entity is incorporated.
A company should exercise care when reorganizing two or more entities because Rev. Rul. 73-526 also provides that in a consolidation, where a new entity is formed to consolidate the activities of two or more other corporations, the newly formed entity must obtain a new EIN and may not use the EIN of one of the predecessor entities.
Issues for Analysis
A company that is considering reorganizing a subsidiary corporation into a single-member LLC that will be disregarded for federal tax purposes should consider the following questions:
- Does the state under the laws of which the corporation is organized have both a conversion statute and a merger statute that allow the corporation to choose how it will reorganize as a single-member LLC? If yes, will using the merger statute impose an undesirable limitation on the LLC’s ability to change its federal tax classification during the following 60 months?
- If the state does not have a conversion statute and the company wants the LLC to retain the predecessor corporation’s EIN, can the corporation merge with a corporation organized under the laws of a different state that does have a conversion statute?
- Must the LLC default to a domestic disregarded entity as of the date of conversion?
- If the company’s reorganization involves multiple conversions of state law corporations to LLCs, which LLCs and EINs will be used to report payroll and excise taxes following the reorganization?
- What are the internal and external costs (including timing costs) if an LLC that is the successor to a state law corporation must obtain a new EIN?
Companies ordinarily give much attention to the various steps involved in reorganizing a corporate structure. That attention should include a thoughtful analysis of what will happen to the historic EIN of a corporation that is to be converted to a single-member LLC.
Editor: Annette B. Smith, CPA
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
For additional information about these items, contact Ms. Smith at (202) 414-1048 or email@example.com.