Bar News - February 18, 2015
Tax Law: Second DRA Ruling Further Clarifies LLC Conversions
By: Beth Fowler
For many years, attorneys were reluctant to convert businesses to limited liability companies, for fear that the NH Department of Revenue Administration would treat the conversion as a taxable event, possibly triggering the business profits tax and real estate transfer tax on any real estate held by the converted entity.
The DRA has now alleviated that concern through the issuance of two declaratory rulings. The second of these rulings, issued last year, amplified the scope of conversion transactions that will be exempt from real estate transfer tax.
In April 2014, the DRA issued Declaratory Ruling 10566, which involved a Massachusetts business trust owning New Hampshire real estate. A limited partnership was the sole trust beneficiary. The limited partnership had a corporate general partner and three limited partners – two individuals and one revocable trust.
The trust intended to engage in a statutory conversion to an LLC. The LLC would have a single member – the limited partnership. The trust represented that no consideration other than LLC membership units would change hands in the conversion. It also represented that the fair market value of the LLC’s assets would be the same as the fair market value of the trust’s assets. Given these facts, the trust requested a ruling on whether real estate transfer tax would apply to the conversion. The trust did not request a ruling on any business tax issues.
The DRA ruled that because there was no exchange of money, property or services, there was no consideration in the conversion interest exchange. Although the ruling does not specifically rule on the issue, the analysis could support a determination that a conversion is not a “bargained-for exchange.”
As in its earlier ruling, issued in July 2013, the DRA held that because only one entity is involved in a conversion, there is no transfer of property. Because there is no transfer, the conversion is not subject to real estate transfer tax.
In its first conversion ruling, Declaratory Ruling 10391, the DRA considered a real estate entity organized and taxed as an S corporation proposing to engage in a statutory conversion from a corporation to an LLC. Following the conversion, the entity would elect S corporation taxation for the LLC. For federal tax purposes, the transaction qualifies as a tax-free “F” reorganization.
Based on the facts presented, the DRA ruled that the proposed S corporation conversion would not trigger any business profits tax liability. Additionally, it found that all tax credits and loss carry-forwards of the S corporation would be available to the LLC after conversion.
DRA also held that distributions from the converted entity would be LLC distributions. Therefore, if the entity has nontransferable equity interests, post-conversion distributions would not be subject to the 5 percent interest and dividends tax.
Limited Liability Companies are, by a wide margin, the most common form of business enterprise in New Hampshire. The flexibility of governance and equity structure, combined with liability protection, provide significant advantages over other entity types.
Distributions from an LLC are, in many cases, exempt from the 5 percent state interest and dividends tax, whereas, distributions from corporations are not. Notably, the New Hampshire LLC statute, RSA 304-C, provides a mechanism for converting another form of entity to an LLC.
The DRA has now found that two different types of statutory conversions of real estate entities are not subject to real estate transfer tax. This is a clear indication that the DRA will not seek to impose transfer tax on any statutory conversion of a real estate entity.
Both of the conversions discussed in the rulings require the same basic procedural steps. At a state level, this includes the filing at the New Hampshire Office of the Secretary of State of a certificate of conversion and LLC formation documents. The entity should adopt a Plan of Conversion and file any federal elections required to complete the conversion.
Although conversions may not have any real estate transfer tax implications, they may have other tax implications. Before engaging in a conversion, an entity should consult with its professional advisors to determine whether a proposed conversion has unintended income tax consequences.
Beth Fowler practices in the tax department of the McLane Law Firm. She can be reached by email.