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The step transaction doctrine clearly has a place in corporate tax; without it, one would become a slave to transactional form and the entire concept of economic substance would, at best, be on life support. What is far less clear is the question of"when" the step transaction doctrine applies. Moreover, this question of "when" really encompasses two questions (1) whether a set of facts is ripe for application of the doctrine, and more insidiously, (2) assuming a set of facts is ripe for application of the doctrine, when in time the doctrine should be applied. The great body of law addressing the step transaction doctrine focuses almost exclusively on the first of these questions, the "whether" question. Virtually no authorities address the second question, the "when" question, although some vexing issues lurk there. FSA 200237017(1) is interesting because it illustrates both aspects of the application of the step transaction doctrine-- it considers both "whether" to apply the doctrine and "when" in the sequence of events it should be applied.
As is well known, the step transaction doctrine generally permits a series of formally separate steps to be amalgamated and treated as a single transaction if they are in substance integrated, interdependent, and focused toward a particular result.2 In FSA 200237017, Corporation X is closely held and, pursuant to applicable state law, its shareholders converted X into a limited liability partnership (LLP). On the same day as this conversion, an election was filed pursuant to the check-thebox regulations3 to treat LLP as a corporation (Newco) for federal income tax purposes, effective on the date the election was filed.
In form we are presented with two steps: (1) the conversion of X into LLP and (2) the conversion of LLP into Newco. If these steps are not amalgamated into a single transaction, the result could be quite unfortunate for the taxpayers, as double tax could result. The conversion of X into LLP would be treated for federal income tax purposes as a complete liquidation of X, followed by a contribution by the former X shareholders of all of the assets and liabilities received in the deemed liquidation to the new partnership.4 A complete liquidation normally subjects both X and its shareholders to tax, pursuant to Sections...