CONVERTING AN S CORP BACK TO AN LLC

[mike9]

II have a client who was an LLC and converted to an S Corp ten years ago. Two LLC memebers

He has no basis due to excessive withdrawals and or Bonus depreciation writeoffs. But has significant outside bases from Debt. mostly to SBA which he can not use since he is an S Corp

Can he convert back to an LLC revoking S status as per Section 1362 A ? striclty to tak advantage of the outside debt basis

.Are their otehr tax implications such as having to disoolve the S Corp and transfer assets at FMV to the llc Etc?

Thanks ofr all your conideration and help

Mike 

[BobKamman]

Did they just elect to be taxed as an S Corp, or did they dissolve the LLC and start a new corporation under state law, which then elected S status?

[mike9]

LLC waas formed in 2006 and immediately converted to a Sub S

[BobKamman]

So it was then and is now and has always been an LLC.  Just taxed as an S corporation for IRS purposes.  And for some reason now wants to go back to being taxed as a partnership.  And there is some SBA loan involved.  They don't plan on paying it off?  Was it a PPP loan?  

[TaxMonkey]

You cannot reorganize back into a partnership.  It would be a corporate liquidation, and given what you said regarding basis and debt there would likely be taxes due.

[BobKamman]

@TaxMonkey   I don't think there was ever a corporation.  It's an LLC that elected S status, and now wants to elect out of it. No change in entity.  

[TaxMonkey]

That makes perfect sense as far as the CA Secretary of State is concerned.  However, the IRS will consider this to be an S-corp liquidation.  They will expect a final S-corp tax return with all of the assets and liabilities distributed out at FMV to the shareholders.

[rbynaker]

I've heard conflicting answers on this and never had to deal with it personally (so never had to research too deeply).

If a MMLLC elects to be taxed as an S Corp, when it revokes the S election (or when an ownership change results in an ineligible shareholder), does it revert to a C Corp or back to a partnership?

Back when I learned this you had to file the 8832 first (electing into corp treatment) and then the 2553 (to get into S).  So I've always assumed that when you undo (or blow) the S you step back into the C.  Then if you wanted partnership you do another 8832.

[TaxMonkey]

Yes, revoking an S election would make a business a C corp.

Filing a partnership election would not change your requirement to liquidate the corporation, with the associated tax consequences.  The IRS would still be looking for a final corp tax return.  The may be circumstances were liquidating a C corp is preferable to liquidating an S corp, but I can't think of any off the top of my head.

[rbynaker]

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@TaxMonkey wrote:

Yes, revoking an S election would make a business a C corp.

Filing a partnership election would not change your requirement to liquidate the corporation, with the associated tax consequences.  The IRS would still be looking for a final corp tax return.  The may be circumstances were liquidating a C corp is preferable to liquidating an S corp, but I can't think of any off the top of my head.

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Thanks.  So it's not the S > C that creates the liquidation problem, it's the S > Partnership or the C > Partnership, right?

[TaxMonkey]

S to C should be tax free.

S or C to partnership has tax consequences as the assets are deemed sold at FMV, which would often be a gain if they are fully depreciated.  This would be complicated by any assumption of liabilities in the liquidation as well.

[mike9]

Thanks you all for yourt awesome responses. I got the following guidance fromt eh IRS site regarding revocation , however it does not address it as a liquidation . 

To revoke a Subchapter S election/small business election that was made on Form 2553, submit a statement of revocation to the service center where you file your annual return.

The statement should state:

• The corporation revokes the election made under Section 1362(a)
• Name of the shareholder(s),
• Address of the shareholder(s),
• Taxpayer identification number of the shareholder(s),
• The number of shares of stock owned by the shareholder(s),
• The date (or dates) on which the stock was acquired
• The date on which the shareholder's taxable year ends
• The name of the S corporation
• The S corporation's EIN
• The election to which the shareholder(s) revokes
• The statement must be signed by the shareholder(s) under penalties of perjury
• Signature and consent of shareholder(s) who collectively own more than 50% of the number of issued and outstanding stock of the corporation, (whether voting or non-voting)
• Indication of the effective date of the revocation (or prospective date)
• Signature of person authorized to sign return

Due Date of Revocation:

• If revoking effective the first day of the tax year, the revocation is due by the 16th day of the third month of the tax year,

[TaxMonkey]

I would not recommend revoking the S election.

[sjrcpa]

@mike9

That's because a mere revocation of the S election simply makes the entity a C Corp for tax purposes.

[sjrcpa]

Are you saying the SBA loan was to the owner and not the entity?

[mike9]

You are right, it is confusing . The IRS instructions  for 1120-S Line 13 Under Schedule B does not address tax consequences. LLC uniersity ( third party ) gives specific diretions  incluidng filing Form 8832 to just revoke the eelction 

[mike9]

Loans were made in the name of the LLC. and guaranteed by the members. 

However these loan balances can not be considered as Outside Basis becasue the LLC filed form 2553 to be txed as a S Corp.

The S Corp has losses but can nto claim them becasue fo basis limitations in an S Corp

We were trying tio revoke the S Corp status in 2023 so we can file a Form 1065 and claim the Outside basis and the loss

[mike9]

Thanks but is there a  Code that says that this will be a "deemed liquidation " ?

I am confused becasue  all you are doing is revoking an election

Now the itnent could be questioned becasue of this revocation is being made  so the LLC now can claim the losses 

[mike9]

Where does it say that ?

[TaxMonkey]

The appropriate reg would be Treas. Reg. § 301.7701-3(g)(ii)

(ii) Association to partnership. If an eligible entity classified as an association elects under paragraph (c)(1)(i) of this section to be classified as a partnership, the following is deemed to occur: The association distributes all of its assets and liabilities to its shareholders in liquidation of the association, and immediately thereafter, the shareholders contribute all of the distributed assets and liabilities to a newly formed partnership.

https://www.law.cornell.edu/cfr/text/26/301.7701-3

[mike9]

Section 301.7701-3(c)(1)(i) provides generally that an eligible entity may elect to be classified other than as provided under 301.7701-3(b), or to change its classification, by filing Form 8832, Entity Classification Election, with the service center designated on Form 8832. Section 301.7701-3(c)(1)(iii) provides that an election made under 301.77013(c)(1)(i) will be effective on the date specified by the entity on Form 8832 or on the date filed if no date is specified on the election form. The effective date specified on Form 8832 cannot be more than 75 days prior to the date on which the election is filed.

[sjrcpa]

Reread TaxMonkey's Regulation cite.

[BobKamman]

Can we all agree on this?

Partnership to Corporation 

An election to change classification from a partnership to a corporation will be treated as if the partnership contributed all of its assets and liabilities to the corporation in exchange for stock and the partnership then immediately liquidated by distributing the stock to its partners.

For more information, see Partnership Distributions in Publication 541, Partnerships and Property Exchanged for Stock in Publication 542, Corporations.

Corporation to Partnership 

An election to change classification from a corporation to a partnership will be treated as if the corporation distributed all of its assets and liabilities to its shareholders in liquidation and the shareholders then immediately contributed all of the distributed assets and liabilities to a new partnership.

For more information, see Contribution of Property in Publication 541, Partnerships and Distributions to Shareholders in Publication 542, Corporations.

https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-possible-rep... 

The right answer, of course, is to tell the clients to make up their fool minds and stick with what they chose or go down the street to H&R Block.  That's why I don't plan on ever dealing with this problem myself.