Merger of target into acquiring corporation's SMLLC is an A reorganization.

• Author: Lerman, Jerry L.
• Position: Corporations & Shareholders - Single-member limited liability company

In Letter Ruling 200236005, the IRS held for the first time that the merger of a target into an acquiring corporation's wholly owned single-member limited liability company (SMLLC) qualified as a tax-free A reorganization. An SMLLC is the most common type of disregarded entity. Due to the increased use of disregarded entities (especially SMLLCs) in mergers and the fact that some states allow such entities to merge with corporations, the IRS has started to address when and whether such arrangements are Sec. 368(a)(1)(A) tax-free statutory mergers. This item discusses only SMLLCs that do not elect to be classified as corporations for Federal tax purposes.

The Merger Rules

The IRS issued proposed regulations in 2001 on how the merger rules apply to transactions involving disregarded entities. In general, it accepted the idea that a corporation could merge into a disregarded entity and qualify as a statutory merger, but that the merger of a disregarded entity into a corporation would not qualify. Although no public hearings were requested or held, the IRS received numerous written comments and, in response, issued temporary regulations that retain the proposed regulations' general framework, with some modifications. Temp. Regs. Sec. 1.368-2T is effective for transactions occurring after Jan. 23, 2003. Taxpayers, however, may apply the rule to transactions occurring before that date in certain situations.

According to the temporary regulations' logic, a statutory merger that meets the Sec. 368 terms and conditions is consistent with, for Federal tax purposes, the general treatment of an SMLLC as a division of its owner. Under those regulations, for A reorganization purposes, a statutory merger or consolidation must be effected pursuant to the laws of the U.S., or a state or the District of Columbia. As such, the following events must occur simultaneously under Temp. Regs. Sec. 1.368-2T(b)(1)(ii) at the effective time of the transaction:

1. All of the assets (other than those distributed in the transaction) and liabilities (except to the extent satisfied or discharged in the transaction) of each member of one or more combining units (transferor units) become the assets and liabilities of one or more members of one other combining unit (transferee unit); and

2. The combining entity of each transferor unit ceases its separate legal existence.

   Temp. Regs. Sec. 1.368-2T (b)(1)(iv) provides eight examples of how the rules apply when an SMLLC is a party...