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The IRS's view of partnership incorporations involving actual transfers is set forth in Rev. Rul. 84-111,1 which makes clear that the method or form selected by the partnership and its partners will be respected for tax purposes. The three alternative forms covered in Rev. Rul. 84-111 are as follows:
* Alternative 1: The partnership contributes its assets to the corporation in exchange for stock of the corporation, which stock is then distributed by the partnership to its partners in a liquidating distribution ("assets-over");
* Alternative 2: The partnership liquidates, distributing its assets to its partners, who then contribute their undivided interests in the assets to the corporation in exchange for stock ("assets-up"); and
* Alternative 3: The partners contribute their partnership interests to the corporation in exchange for stock.
The IRS's view of an elective change in tax classification from partnership status to association status (i.e., where the entity does not change its form under state law but changes it tax classification) is set forth in Regs. §301.7701-3(g)(1)(i). Such a classification change is treated as if an assets-over transaction has occurred.
Recently, the IRS issued Rev. Rul. 2004-59,2 providing guidance on the federal tax treatment of a formless conversion of a state law unincorporated entity classified as a partnership for federal tax purposes into a state law corporation, which under the federal tax classification regulations is bound to have association status. In the ruling, the IRS states that an unincorporated entity that makes such a conversion will be treated "in the same manner as one that makes an election to be treated as an association under [Regs.] §301.7701-3(c)(1)(i)." The IRS explained that the following steps are deemed to occur: The unincorporated entity contributes all of its assets and liabilities to the corporation in exchange for stock in the corporation, and immediately thereafter, the unincorporated entity liquidates, distributing the stock to its partners. Thus, generally no gain or loss should be recognized on the conversion because §351 should apply to the deemed transfer of the partnership's assets to the new corporation, and §731 should apply to the deemed liquidation of the partners from the partnership in exchange for stock of the corporation.
This guidance, the general approach of which will not come...