Termination of an LLC.

• Author: Ellentuck, Albert B.
• Position: Limited liability companies

ALTHOUGH THE LEGAL TERMINATION OF an LLC classified as a partnership is determined under state law, termination for tax purposes is determined under the specific provisions of Sec. 708. LLCs terminate under the tax law either because the LLC's business ceases or because 50% or more of the LLC's profits and capital interests are transferred within a 12-month period. The mechanical nature of these rules allows the practitioner to determine with a great degree of certainty whether the LLC has terminated for tax purposes. Sec. 708 can also cause the unintended termination of an LLC under the "technical termination" provisions (50% or more ownership change in 12 months), along with the related tax ramifications. In fact, many partnerships and LLCs have been terminated without the partners' or members' knowledge.

The general rule for determining whether an event triggers the termination of an LLC classified as a partnership is found in Sec. 708(b)(1). The rule identifies the following two events as those that cause an LLC termination for tax purposes:

1. No part of any business, financial operation, or venture of the LLC continues to be carried on by any of its members in an LLC or partnership (including when the LLC has fewer than two members). Conversion of a partnership to an LLC (and vice versa) does not terminate the converting entity.

2. The sale or exchange of a 50% or more interest in LLC capital and profits within a 12-month period (which can include parts of two tax years).

Caution: The provisions of Sec. 708 are the only criteria used to determine whether an LLC classified as a partnership is terminated for tax purposes. The legal dissolution of an LLC under state law because of the death, withdrawal, bankruptcy, or incompetence of a member does not result in an LLC termination for tax purposes if the event does not trigger one of the two events previously described.

In certain situations, it may be advisable for an LLC to terminate for tax reasons. For example, if a Sec. 754 basis adjustment election has been missed and the IRS has rejected the LLC's request for relief, a termination may be the only way to achieve a basis step-up. In other cases, it may be desirable to continue the legal existence of an LLC, even when the LLC has terminated for tax purposes and distributed all its operating assets. This may be the case, for example, if there is an issue about who the tax management partner would be on a subsequent audit of the LLC...