Category: Partnerships Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Taxpayers, A and B, are two limited liability companies (LLC's) taxed as partnerships. Both LLC's are owned in the same proportions by the same two individuals. Both LLC's are engaged in similar lines of business and wish to merge B into A with A being the survivor of the merger. The purpose of this memorandum is to discuss the federal income tax consequences of such a merger. Normally local corporate law provides a statutory mechanism by which corporations can be merged. With partnerships, that is not the case. Neither the Uniform Partnership Act nor the Uniform Limited Partnership Act provide such a mechanism. A merger of partnerships must be accomplished by agreement among the parties. The taxpayers in this case are neither corporations nor partnerships, they are LLC's. I am not an attorney. Competent legal counsel in your jurisdiction should be consulted to determine whether state law provides a mechanism for merging LLC's or whether it is necessary to draft a contract under which the parties agree to take steps to effect a merger. In the absence of an enabling staute, there are two ways to accomplish a merger of partnerships or limited liability companies. 1) All the assets and liabilities of B could be contributed to A in exchange for membership interests of A. Thereafter, B would liquidate and distribute the A interests to the members of B. 2) B could be liquidated, and the members of B could then contribute the assets received and liabilities assumed to A. It seems to me the first method should be the cleaner of the two administratively, and absent some compelling tax reason to do otherwise, the agreement of merger should be drafted to take that form. Although I can see no difference between either of these methods based on my limited knowledge of the taxpayers' affairs, you should use your detailed knowledge of the taxpayers' books and records and other circumstances to verify that conclusion. I will gladly assist you if you so desire. Here is an overview of the tax consequences. 1. The contribution of B assets and liabilities to A is controlled by Section 721. No gain or loss should be recognized either to A or B assuming the liabilities assumed by A in the transaction do not exceed the tax basis of B's assets contributed to A. B's asset basis should carry over to A. As I understand it, B has only cash and zero-basis accounts receivable. B also has debt owed to A as well as a limited amount of third-party accounts payable. This situation seems ripe for liabilities in excess of basis. Please look closely at this issue. 2. The liquidation of B is controlled by Section 731. No gain or loss should be recognized by B or its members. The basis of A membership interests distributed in liquidation is controlled by Section 732(b) which provides that the basis of assets distributed in liquidation (other than money) is the basis of partners' interests in the liquidated partnership reduced by any money distributed in the same transaction. 3. The existence of B terminates on liquidation. A final tax return must be filed for B covering the period January 1, 1998 through the date of liquidation. That return is due on or before the 15th day of the fourth month following the end of the month in which the liquidation occurs. Suppose the liquidation occurs April 15, 1998. The final return for B must be filed by August 15, 1998. 4. The return for A will cover the whole calendar year and include the operations of A for the entire year plus the operations of B for the portion of the year following the merger. Follow-up Issues 1. As I understand it B has only cash, cash basis accounts receivable, minor accounts payable, and related party debt (owed principally to A). When the two entities merge, the debt owed to A effectively goes away. Is this intercompany debt providing basis needed to support losses? If so, the merger could create unexpected gainor the unexpected inability to currently utilize lossesas a result of reduced tax basis. 2. Are the two entities using the same methods of accounting? Disparate methods of accounting would require additional thought as to which method should control and how to transition from one method to the other for the portion of the operations forced to change methods. 3. Does B have any valuable tax elections or methods of accounting that should be preserved, for example because A would for some reason be unable to make a similar election or adopt a similar method of accounting? |
