ENTITY COMPARISON CHART By
Why LLCs are Now the Entity of Choice in Pennsylvania Webinar Noon-1 p.m. June 1, 2016 Wendi Kotzen, Partner Ballard Spahr, Philadelphia
William H. Clark Jr., Partner Drinker, Biddle and Reath, Philadelphia
Saba Ashraf, Partner Ballard Spahr, Philadelphia
A Brief Review of Entity Law Basics Relating to Choice of Entity William H. Clark, Jr. Drinker Biddle & Reath LLP One Logan Square Philadelphia, PA 19103 (215) 988-2804 [email protected]
general approach on choice of entity • • • •
always: reduce taxes limit the liability of the owners and usually: protect the people in charge while: implementing the governance arrangement desired by the owners
liability of owners corporation
good
– shareholders protected
general partnership
bad
– partners jointly and severally liable
LLP – PA partial shield – DE full shield
limited partnership
mixed
– general partners liable
LLLP – full or partial shield for general partners
limited liability company
good
– members protected
business trust – beneficial owners protected
good
protection of those in charge • exoneration – authorized by statute for corporations (and indirectly for some limited liability companies) – available by contract for other types of entities
• indemnification – authorized by statute for corporations, limited partnerships, and limited liability companies – available by contract for other types of entities
• advancement of expenses – authorized by statute for corporations, limited partnerships, and limited liability companies – available by contract for other types of entities
• variation of duties – available in Delaware, but currently not in Pennsylvania
governance arrangements • there are three basic governance paradigms: 1. corporation
board with overall responsibility and officers
2. general partnership
all owners actively participate in management
3. limited partnership
one or more managers locked into position
• the three paradigms largely may be replicated in any type of entity organized under Pennsylvania law – this is true even for corporations because of the validation of freedom of contract in 15 Pa.C.S. § 1306(a)(8)(ii) and (b)
ENTITY COMPARISON CHART By
Wendi L. Kotzen Saba Ashraf Ballard Spahr LLP
William H. Clark, Jr. Drinker, Biddle & Reath May 2016
TAX
C CORP
LIMITED PARTNERSHIP
S CORP
LIMITED LIABILITY PARTNERSHIP
GENERAL PARTNERSHIP
LIMITED LIABILITY COMPANY
BUSINESS TRUST
ORGANIZE TAX FREE
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
TAX FREE CONTRIBUTION OF PROPERTY AFTER FORMATION
GENERALLY NO
GENERALLY NO
YES
YES
YES
YES
YES
TAX ON DEBT IN EXCESS OF BASIS OF CONTRIBUTED PROP
YES
YES
POSSIBLY
POSSIBLY
POSSIBLY
POSSIBLY
POSSIBLY
CAN HAVE CORPORATE OWNER
YES
NO (EXEMPT ORG CORPORATE OWNERS WILL NOT CAUSE LOSS OF S STATUS)
YES
YES
YES
YES
YES
NEED TWO OWNERS
NO
NO
YES
YES
YES
NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES
NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES
MAXIMUM NUMBER OF OWNERS
NO
100
NO
NO
NO
NO
NO
This chart assumes that each entity that is not a state law corporation does not elect to be treated as a corporation and is not publicly traded.
7
TAX
C CORP
S CORP
LIMITED PARTNERSHIP
LIMITED LIABILITY PARTNERSHIP
GENERAL PARTNERSHIP
LIMITED LIABILITY COMPANY
BUSINESS TRUST
NO
YES
YES
YES
YES
YES
YES
NO
YES, EXCEPT INCOME SUBJECT TO FIT (e.g., BUILT-IN GAINS) SUBJECT TO CNIT
YES
YES
YES
YES
YES
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS’ TAX UPON FAILURE TO WITHHOLD
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
PASS THROUGH FED PASS THROUGH PA INC TAX
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL SHAREHOLDERS FOR TAX YEARS BEGINNING AFTER 12/31/2014, S CORPS WITH 11 OR MORE SHAREHOLDERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE SHAREHOLDERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS’ ACTUAL TAX LIABILITY
8
TAX ELECTION REQUIRED FOR FEDERAL, PA
C CORP NO
S CORP YES
LIMITED PARTNERSHIP
LIMITED LIABILITY PARTNERSHIP
GENERAL PARTNERSHIP
LIMITED LIABILITY COMPANY
BUSINESS TRUST
NO
NO
NO
NO
NO
PA FOLLOWS FEDERAL (UNLESS ELECTION TO OPT OUT)
PA CAPITAL STOCK TAX PHASED OUT EFFECTIVE 1/1/16
N/A
N/A
N/A
N/A
N/A
N/A
N/A
OWNER GETS BASIS FOR ENTITY’S DEBT
NO
NO
YES
YES
YES
YES
YES
CALENDAR OR BUSINESS YEAR REQUIRED CAN HAVE SUBSIDIARIES CAN BE DISREGARDED FOR FIT PURPOSES
NO
YES
YES
YES
YES, WITH CERTAIN EXCEPTIONS
YES
YES
YES
YES
YES
YES
YES
YES
YES
NO
NO
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
CITY OF PHILADELPHIA TAXES
BUSINESS INCOME AND RECEIPTS TAX (FORMERLY BUSINESS PRIVILEGE TAX)
BUSINESS INCOME AND RECEIPTS TAX
BUSINESS INCOME AND RECEIPTS TAX
BUSINESS INCOME AND RECEIPTS TAX
BUSINESS INCOME AND RECEIPTS TAX
FOLLOWS FIT
BUSINESS INCOME AND RECEIPTS TAX
QSSS NOT TREATED AS SEPARATE ENTITY BUT S CORP. PARENT AND QSSS TREATED AS ONE ENTITY AND SUBJECT TO BPT.
NET PROFITS TAX
NET PROFITS TAX
NET PROFITS TAX
(GENERALLY NO PASSTHROUGH ENTITIES)
BUSINESS INCOME AND RECEIPTS TAX (IF DRE, THEN OWNER SUBJECT TO BIRT AND - IF APPLICABLE - NPT)
NET PROFITS TAX
9
SUBJECT TO AT RISK RULES SUBJECT TO PASSIVE ACTIVITY LOSS RULES ACCRUAL METHOD REQUIRED
NO, UNLESS CLOSELY HELD NO, UNLESS CLOSELY HELD
YES
LIMITED PARTNERSHIP YES
YES
YES
YES
YES
YES
YES
YES, UNLESS QPSC OR GR
NO, UNLESS IT HAS INVENTORY
NOT ON DIVIDENDS
ISSUES EXIST FOR OE
YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELFEMPLOYMENT TAX.
YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GENERAL PARTNER'S EARNINGS FROM SELFEMPLOYMENT INCLUDE DISTRIBUTIVE SHARE OF INCOME OR LOSS AND GUARANTEED PAYMENTS FOR SERVICES RENDERED. LIMITED PARTNERS ONLY INLUCLUDE GUARANTEED PAYMENTS.
YES IF C CORP MEMBER OR TAX SHELTER UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELFEMPLOYMENT TAX.
YES IF C CORP MEMBER OR TAX SHELTER UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY
EMPLOYMENT TAX/ SELFEMPLOYMENT TAX
YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELFEMPLOYMENT TAX.
TAX
C CORP
S CORP
LIMITED LIABILITY PARTNERSHIP YES
GENERAL PARTNERSHIP YES
LIMITED LIABILITY COMPANY YES
YES
BUSINESS TRUST
YES ON ALLOCABLE SHARE OF INCOME IF MEMBER HAS PERSONAL LIABILITY FOR DEBT OR CLAIMS VS. ENTITY, AUTHORITY TO CONTRACT ON BEHALF OF THE BUSINESS TRUST OR PARTICIPATES IN THE BUSINESS TRUST’S TRADE OR BUSINESS FOR MORE THAN 500 HOURS DURING THE BUSINESS TRUST’S TAX YEAR; IF MEMBER IS SERVICE MEMBER
10
TAX
C CORP
S CORP
3.8% NET INVESTMENT INCOME TAX
MAY BE IMPOSED ON GAIN FROM SALES OF STOCK AND DIVIDENDS EARNED BY INDIVIDUAL SHAREHOLDERS
MAY BE IMPOSED ON GAIN FROM SALES OF STOCK AND OTHER INCOME EARNED BY INDIVIDUAL SHAREHOLDERS IF OWNERSHIP IS A PASSIVE ACTIVITY
DOUBLE TAX ON SALE OF ASSETS CAN RECEIVE STOCK TAX FREE IN A MERGER ENTITY ASSET BASIS STEP UP ON TRANSFER BY OWNER BY SALE OR DEATH
YES
YES
NO, UNLESS TAX ON BUILT IN GAIN YES
NO
NO
LIMITED PARTNERSHIP MAY BE IMPOSED ON GAIN FROM SALES OF PARTNERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL PARTNERS IF OWNERSHIP IS A PASSIVE ACTIVITY
NO
LIMITED LIABILITY PARTNERSHIP MAY BE IMPOSED ON GAIN FROM SALES OF PARTNERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL PARTNERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO
GENERAL PARTNERSHIP MAY BE IMPOSED ON GAIN FROM SALES OF PARTNERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL PARTNERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO
LIMITED LIABILITY COMPANY MAY BE IMPOSED ON GAIN FROM SALES OF MEMBERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL MEMBERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO
NO
NO
NO
NO
NO
YES WITH 754 ELECTION
YES WITH 754 ELECTION
YES WITH 754 ELECTION
YES WITH 754 ELECTION
YES WITH 754 ELECTION
BUSINESS TRUST MAY BE IMPOSED ON GAIN FROM SALES OF INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL IF OWNERSHIP IS A PASSIVE ACTIVITY
NO
QPSC = QUALIFIED PERSONAL SERVICE CORP. GR = GROSS RECEIPTS UNDER $10,000,000 OE = OWNER EMPLOYEE QSSS = QUALIFIED SUBCHAPTER S SUBSIDIARY 11
BUSINESS
C CORP
S CORP
LIMITED PARTNERSHIP YES FOR LIMITED PARTNERS
LIMITED LIABILITY PARTNERSHIP DEPENDS ON STATE STATUTE. DELAWARE OFFERS FULL SHIELD. PENNSYLVANIA— PARTNERS ARE NOT LIABLE FOR MISCONDUCT OF OTHER PARTNERS BUT ARE LIABLE FOR OBLIGATIONS OF THE COMPANY.
GENERAL PARTNERSHIP NO
LIMITED LIABILITY COMPANY YES
BUSINESS TRUST
LIMITED LIABILITY FOR OWNERS
YES
YES
LIMITED LIABILITY OF DIRECTORS/ MANAGERS/ OFFICERS IMPACT OF DEATH OF AN OWNER ON THE BUSINESS
YES
YES
NO, FOR GENERAL PARTNER
SOME FOR GENERAL PARTNER
NO
DEPENDS ON STATUTE
DEPENDS ON STATUTE
NONE
NONE
STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE
STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE
STATUTORY DISSOLUTION
DEPENDS ON STATUTE, MOST ARE THE SAME AS FOR A LIMITED PARTNERSHIP
NONE
YES
YES, BUT RESTRICTIONS DESIRABLE YES
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
NO
NO
NO
NO
NO
(PARTNERSHIP / LLC AGREEMENTS MAY PROVIDE OTHERWISE) TRANSFERABILITY OF INTERESTS IN ENTITY ARE ANNUAL ELECTIONS OF DIRECTORS, MANAGERS, AND OFFICERS REQUIRED
YES
YES
12
FEDERAL AND PENNSYLVANIA INCOME TAX CONSEQUENCES OF STATE ENTITY CONVERSIONS
LP TO LLC AND LLC TO LP
CORPORATION TO LLC AND LLC TO CORPORATION
LP TO LLC
LLC TO LP – WILL BE VERY RARE
GENERALLY A CONVERSION FROM AN LP TO AN LLC WILL NOT BE TAXABLE TO THE LIMITED PARTNERS. LIMITED PARTNERS WILL HAVE A TAX BASIS FOR THEIR MEMBERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS, PLUS THEIR SHARE OF THE LLC’S RECOURSE DEBT. THE GENERAL PARTNER’S BASIS FOR ITS MEMBERSHIP INTEREST WILL DECREASE BY THE OTHER MEMBER’S SHARE OF THE LLC’S RECOURSE DEBT. THE GENERAL PARTNER COULD RECOGNIZE GAIN IF THERE IS A DECREASE IN ITS SHARE OF LIABILITIES AND THE DECREASE EXCEEDS THE PARTNER'S BASIS FOR ITS PARTNERSHIP INTEREST. THE LLC'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LP HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE PARTNERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES.
GENERALLY CONVERSION FROM AN LLC TO AN LP WILL NOT BE TAXABLE TO THE LLC MEMBERS. THE LIMITED PARTNERS WILL HAVE A BASIS FOR THEIR LIMITED PARTNERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LP’S RECOURSE DEBT. THE GENERAL PARTNER WILL HAVE A BASIS FOR ITS GENERAL PARTNERSHIP INTEREST EQUAL TO ITS BASIS FOR ITS MEMBERSHIP INTEREST PLUS THE OTHER MEMBER’S SHARE OF THE RECOURSE DEBT. THE LP'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LLC HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE MEMBERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES.
CORPORATION TO LLC – WILL BE VERY RARE
LLC TO CORPORATION
THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE MEMBERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR MEMBERSHIP INTERESTS. THE LLC WILL HAVE A FAIR MARKET VALUE BASIS FOR ITS ASSETS. FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS.
THE CONVERSION WILL BE TAX-FREE UNLESS THE LLC’S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE CORPORATION’S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE LLC HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LLC’S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE LLC’S DEBT EXCEEDS THEIR BASIS FOR THEIR MEMBERSHIP INTEREST.
13
CORPORATION TO LP AND LP TO CORPORATION
CORPORATION TO LP – WILL BE VERY RARE
LP TO CORPORATION
THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE PARTNERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR PARTNERSHIP INTERESTS PLUS THEIR SHARE OF THE PARTNERSHIP’S NON RECOURSE DEBT. THE PARTNERSHIP WILL HAVE A BASIS FOR ITS ASSETS EQUAL TO THE FAIR MARKET VALUE OF THE ASSETS FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS.
THE CONVERSION WILL BE TAX-FREE UNLESS THE PARTNERSHIP’S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE PARTNERSHIP’S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE PARTNERSHIP HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS LESS THEIR SHARE OF THE PARTNERSHIP’S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE PARTNERSHIP’S DEBT EXCEEDS THEIR BASIS FOR THEIR PARTNERSHIP INTEREST.
14
15
Conversion of Entities under Pennsylvania Law William H. Clark, Jr. Drinker Biddle & Reath LLP One Logan Square Philadelphia, PA 19103 (215) 988-2804 [email protected]
16
• Since July 1, 2015, Pennsylvania has authorized the conversion of entities from one form to another. • The conversion provisions are found in 15 Pa.C.S. Subch. 3E and are part of a complete set of inter-entity transaction provisions. • The provisions of 15 Pa.C.S. Ch. 3 apply to transactions involving only Pennsylvania entities and also those involving an entity organized under the law of a foreign jurisdiction that permits inter-entity transactions. 16
17
conversion (I) (single state)
L.P. A (PA)
LLC A (PA)
18
conversion (II) (multi-state)
L.P. A (DE)
LLC A (PA)
19
The only trick to using the new provisions is learning a new vocabulary: – – – – – – – –
governor interest interest holder organic law organic rules private organic rules public organic record “entity” v. “association” 19
20
– Governor: a person by or under whose authority the powers of an association are exercised and under whose direction the activities and affairs of the association are managed pursuant to the organic law and organic rules of the association. For example: • director of a business corporation • manager of a manager-managed LLC • member of a member-managed LLC
20
21
– Interest: a share in a corporation for profit, a membership or share in a corporation not-for-profit, a governance interest, or a distributional interest. For example: • share in a business corporation • membership interest in an LLC
– Interest holder: a direct or record holder of an interest. For example: • shareholder of a business corporation • member of an LLC
21
22
– Organic law: the law of the jurisdiction of formation of an association governing its internal affairs. For example: • the Business Corporation Law of 1988 • the Limited Liability Company Law of 1994
– Organic rules: the public organic record and private organic rules of an association. For example: • articles and bylaws of a business corporation • certificate of formation and operating agreement of an LLC
22
23
– Private organic rules: the rules that govern the internal affairs of an association, are binding on all its interest holders and are not part of its public organic record, if any. For example • bylaws of a business corporation • operating agreement of an LLC
– Public organic record: the document the public filing of which by the department or a similar agency in another jurisdiction is required to form an association. For example: • articles of a business corporation • certificate of formation of an LLC 23
“entity” v. “association” • An “entity” is a domestic or foreign organization of a type whose organic law is found in Title 15. • In contrast, “association” is a broader term that includes any type of private organization, whether domestic or foreign. – A banking institution is an association but not an entity.
association
entity
24
25
• The definitions just discussed are found in 15 Pa.C.S. § 102. – Thus, they apply to all of Title 15 and all of the Pennsylvania business entity laws.
• Definitions applicable just to Chapter 3 relating to fundamental transactions appear in 15 Pa.C.S. § 312. – These definitions are mostly unremarkable and simply facilitate the wording of Chapter 3. – Three definitions are worth noting and will be discussed later: • “interest holder liability” • “protected agreement” • “protected governance agreement”
25
26
procedures generally • The statutory provisions for conversions parallel the provisions for other types of transactions under Ch. 3: – – – – – –
authorization of the transaction preparation of a plan approval of the plan by the governors and interest holders amendment or abandonment of the plan filing and effectiveness effect of the transaction
• Substantive approval requirements under current law continue unchanged. – These are collected in a separate Subchapter 3B and organized by type of entity. 26
27
• Note that the general rule in Pennsylvania is that approval of a fundamental transaction requires the affirmative vote of a majority of the votes cast (which excludes abstentions) at a meeting at which a quorum is present. • This is in marked contrast to Delaware where approval requires the affirmative vote of a majority of the outstanding interests. 27
28
dissenters rights • Dissenters rights are available for shareholders on a conversion. • Statutory dissenters rights are not available for interest holders in entities that are not business corporations.
• Contractual dissenter rights are available for interest holders in entities that are not business corporations. See 15 Pa.C.S. § 317. 28
29
special treatment • 15 Pa.C.S. § 329 permits a plan to classify interest holders into groups on a basis other than the class or series of interest that they hold and provide mandatory treatment for members of the group. • This “special treatment” will be respected if either: 1. the interest holders receiving special treatment have either: • a class vote, or • dissenters rights
2. a court of competent jurisdiction finds that the special treatment was undertaken in good faith, after reasonable deliberation and was in the best interest of the association.
30
protected agreements • The concept of a “protected agreement” or “protected governance agreement” provides transitional protection. • These concepts are defined in 15 Pa.C.S. § 312 as follows: “Protected agreement.” Either of the following: (1) A record evidencing indebtedness and any related agreement in effect on July 1, 2015. (2) A protected governance agreement. “Protected governance agreement.” Either of the following: (1) The organic rules of a domestic entity or foreign association in effect on July 1, 2015. (2) An agreement that is binding on any of the governors or interest holders of a domestic entity or foreign association on July 1, 2015.
31
• If such an agreement deals with a merger, the agreement is deemed to apply to a conversion. • The notion is that, if people contracted for special rules or protections in the event of a merger at a time when conversions were not authorized, they are deemed to have wanted the same special arrangements for a conversion. – Underlying the concept is a recognition that a conversion could previously have been accomplished by using a merger.
32
interest holder liability • Interest holder liability is defined in 15 Pa.C.S. § 312 and is personal liability for either: – a liability of an association as a result of being an interest holder; or – an obligation to contribute to the association imposed by the organic rules.
• A transaction must be approved by any person that will have interest holder liability following the transaction. 32
33
A
General Partnership
B
Corporation
A
B
General Partnership
A
B
General Partnership
Corporation
A
B
Corporation
33
Thank you for attending Questions? ballardspahr.com
drinkerbiddle.com
William H. Clark Jr., Partner Drinker, Biddle and Reath, Philadelphia
Saba Ashraf, Partner Ballard Spahr, Philadelphia
A Brief Review of Entity Law Basics Relating to Choice of Entity William H. Clark, Jr. Drinker Biddle & Reath LLP One Logan Square Philadelphia, PA 19103 (215) 988-2804 [email protected]
general approach on choice of entity • • • •
always: reduce taxes limit the liability of the owners and usually: protect the people in charge while: implementing the governance arrangement desired by the owners
liability of owners corporation
good
– shareholders protected
general partnership
bad
– partners jointly and severally liable
LLP – PA partial shield – DE full shield
limited partnership
mixed
– general partners liable
LLLP – full or partial shield for general partners
limited liability company
good
– members protected
business trust – beneficial owners protected
good
protection of those in charge • exoneration – authorized by statute for corporations (and indirectly for some limited liability companies) – available by contract for other types of entities
• indemnification – authorized by statute for corporations, limited partnerships, and limited liability companies – available by contract for other types of entities
• advancement of expenses – authorized by statute for corporations, limited partnerships, and limited liability companies – available by contract for other types of entities
• variation of duties – available in Delaware, but currently not in Pennsylvania
governance arrangements • there are three basic governance paradigms: 1. corporation
board with overall responsibility and officers
2. general partnership
all owners actively participate in management
3. limited partnership
one or more managers locked into position
• the three paradigms largely may be replicated in any type of entity organized under Pennsylvania law – this is true even for corporations because of the validation of freedom of contract in 15 Pa.C.S. § 1306(a)(8)(ii) and (b)
ENTITY COMPARISON CHART By
Wendi L. Kotzen Saba Ashraf Ballard Spahr LLP
William H. Clark, Jr. Drinker, Biddle & Reath May 2016
TAX
C CORP
LIMITED PARTNERSHIP
S CORP
LIMITED LIABILITY PARTNERSHIP
GENERAL PARTNERSHIP
LIMITED LIABILITY COMPANY
BUSINESS TRUST
ORGANIZE TAX FREE
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
GENERALLY YES
TAX FREE CONTRIBUTION OF PROPERTY AFTER FORMATION
GENERALLY NO
GENERALLY NO
YES
YES
YES
YES
YES
TAX ON DEBT IN EXCESS OF BASIS OF CONTRIBUTED PROP
YES
YES
POSSIBLY
POSSIBLY
POSSIBLY
POSSIBLY
POSSIBLY
CAN HAVE CORPORATE OWNER
YES
NO (EXEMPT ORG CORPORATE OWNERS WILL NOT CAUSE LOSS OF S STATUS)
YES
YES
YES
YES
YES
NEED TWO OWNERS
NO
NO
YES
YES
YES
NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES
NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES
MAXIMUM NUMBER OF OWNERS
NO
100
NO
NO
NO
NO
NO
This chart assumes that each entity that is not a state law corporation does not elect to be treated as a corporation and is not publicly traded.
7
TAX
C CORP
S CORP
LIMITED PARTNERSHIP
LIMITED LIABILITY PARTNERSHIP
GENERAL PARTNERSHIP
LIMITED LIABILITY COMPANY
BUSINESS TRUST
NO
YES
YES
YES
YES
YES
YES
NO
YES, EXCEPT INCOME SUBJECT TO FIT (e.g., BUILT-IN GAINS) SUBJECT TO CNIT
YES
YES
YES
YES
YES
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS’ TAX UPON FAILURE TO WITHHOLD
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
PASS THROUGH FED PASS THROUGH PA INC TAX
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL SHAREHOLDERS FOR TAX YEARS BEGINNING AFTER 12/31/2014, S CORPS WITH 11 OR MORE SHAREHOLDERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE SHAREHOLDERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS’ ACTUAL TAX LIABILITY
FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS’ ACTUAL TAX LIABILITY
8
TAX ELECTION REQUIRED FOR FEDERAL, PA
C CORP NO
S CORP YES
LIMITED PARTNERSHIP
LIMITED LIABILITY PARTNERSHIP
GENERAL PARTNERSHIP
LIMITED LIABILITY COMPANY
BUSINESS TRUST
NO
NO
NO
NO
NO
PA FOLLOWS FEDERAL (UNLESS ELECTION TO OPT OUT)
PA CAPITAL STOCK TAX PHASED OUT EFFECTIVE 1/1/16
N/A
N/A
N/A
N/A
N/A
N/A
N/A
OWNER GETS BASIS FOR ENTITY’S DEBT
NO
NO
YES
YES
YES
YES
YES
CALENDAR OR BUSINESS YEAR REQUIRED CAN HAVE SUBSIDIARIES CAN BE DISREGARDED FOR FIT PURPOSES
NO
YES
YES
YES
YES, WITH CERTAIN EXCEPTIONS
YES
YES
YES
YES
YES
YES
YES
YES
YES
NO
NO
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
CITY OF PHILADELPHIA TAXES
BUSINESS INCOME AND RECEIPTS TAX (FORMERLY BUSINESS PRIVILEGE TAX)
BUSINESS INCOME AND RECEIPTS TAX
BUSINESS INCOME AND RECEIPTS TAX
BUSINESS INCOME AND RECEIPTS TAX
BUSINESS INCOME AND RECEIPTS TAX
FOLLOWS FIT
BUSINESS INCOME AND RECEIPTS TAX
QSSS NOT TREATED AS SEPARATE ENTITY BUT S CORP. PARENT AND QSSS TREATED AS ONE ENTITY AND SUBJECT TO BPT.
NET PROFITS TAX
NET PROFITS TAX
NET PROFITS TAX
(GENERALLY NO PASSTHROUGH ENTITIES)
BUSINESS INCOME AND RECEIPTS TAX (IF DRE, THEN OWNER SUBJECT TO BIRT AND - IF APPLICABLE - NPT)
NET PROFITS TAX
9
SUBJECT TO AT RISK RULES SUBJECT TO PASSIVE ACTIVITY LOSS RULES ACCRUAL METHOD REQUIRED
NO, UNLESS CLOSELY HELD NO, UNLESS CLOSELY HELD
YES
LIMITED PARTNERSHIP YES
YES
YES
YES
YES
YES
YES
YES, UNLESS QPSC OR GR
NO, UNLESS IT HAS INVENTORY
NOT ON DIVIDENDS
ISSUES EXIST FOR OE
YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELFEMPLOYMENT TAX.
YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GENERAL PARTNER'S EARNINGS FROM SELFEMPLOYMENT INCLUDE DISTRIBUTIVE SHARE OF INCOME OR LOSS AND GUARANTEED PAYMENTS FOR SERVICES RENDERED. LIMITED PARTNERS ONLY INLUCLUDE GUARANTEED PAYMENTS.
YES IF C CORP MEMBER OR TAX SHELTER UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELFEMPLOYMENT TAX.
YES IF C CORP MEMBER OR TAX SHELTER UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY
EMPLOYMENT TAX/ SELFEMPLOYMENT TAX
YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELFEMPLOYMENT TAX.
TAX
C CORP
S CORP
LIMITED LIABILITY PARTNERSHIP YES
GENERAL PARTNERSHIP YES
LIMITED LIABILITY COMPANY YES
YES
BUSINESS TRUST
YES ON ALLOCABLE SHARE OF INCOME IF MEMBER HAS PERSONAL LIABILITY FOR DEBT OR CLAIMS VS. ENTITY, AUTHORITY TO CONTRACT ON BEHALF OF THE BUSINESS TRUST OR PARTICIPATES IN THE BUSINESS TRUST’S TRADE OR BUSINESS FOR MORE THAN 500 HOURS DURING THE BUSINESS TRUST’S TAX YEAR; IF MEMBER IS SERVICE MEMBER
10
TAX
C CORP
S CORP
3.8% NET INVESTMENT INCOME TAX
MAY BE IMPOSED ON GAIN FROM SALES OF STOCK AND DIVIDENDS EARNED BY INDIVIDUAL SHAREHOLDERS
MAY BE IMPOSED ON GAIN FROM SALES OF STOCK AND OTHER INCOME EARNED BY INDIVIDUAL SHAREHOLDERS IF OWNERSHIP IS A PASSIVE ACTIVITY
DOUBLE TAX ON SALE OF ASSETS CAN RECEIVE STOCK TAX FREE IN A MERGER ENTITY ASSET BASIS STEP UP ON TRANSFER BY OWNER BY SALE OR DEATH
YES
YES
NO, UNLESS TAX ON BUILT IN GAIN YES
NO
NO
LIMITED PARTNERSHIP MAY BE IMPOSED ON GAIN FROM SALES OF PARTNERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL PARTNERS IF OWNERSHIP IS A PASSIVE ACTIVITY
NO
LIMITED LIABILITY PARTNERSHIP MAY BE IMPOSED ON GAIN FROM SALES OF PARTNERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL PARTNERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO
GENERAL PARTNERSHIP MAY BE IMPOSED ON GAIN FROM SALES OF PARTNERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL PARTNERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO
LIMITED LIABILITY COMPANY MAY BE IMPOSED ON GAIN FROM SALES OF MEMBERSHIP INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL MEMBERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO
NO
NO
NO
NO
NO
YES WITH 754 ELECTION
YES WITH 754 ELECTION
YES WITH 754 ELECTION
YES WITH 754 ELECTION
YES WITH 754 ELECTION
BUSINESS TRUST MAY BE IMPOSED ON GAIN FROM SALES OF INTERESTS AND OTHER INCOME EARNED BY INDIVIDUAL IF OWNERSHIP IS A PASSIVE ACTIVITY
NO
QPSC = QUALIFIED PERSONAL SERVICE CORP. GR = GROSS RECEIPTS UNDER $10,000,000 OE = OWNER EMPLOYEE QSSS = QUALIFIED SUBCHAPTER S SUBSIDIARY 11
BUSINESS
C CORP
S CORP
LIMITED PARTNERSHIP YES FOR LIMITED PARTNERS
LIMITED LIABILITY PARTNERSHIP DEPENDS ON STATE STATUTE. DELAWARE OFFERS FULL SHIELD. PENNSYLVANIA— PARTNERS ARE NOT LIABLE FOR MISCONDUCT OF OTHER PARTNERS BUT ARE LIABLE FOR OBLIGATIONS OF THE COMPANY.
GENERAL PARTNERSHIP NO
LIMITED LIABILITY COMPANY YES
BUSINESS TRUST
LIMITED LIABILITY FOR OWNERS
YES
YES
LIMITED LIABILITY OF DIRECTORS/ MANAGERS/ OFFICERS IMPACT OF DEATH OF AN OWNER ON THE BUSINESS
YES
YES
NO, FOR GENERAL PARTNER
SOME FOR GENERAL PARTNER
NO
DEPENDS ON STATUTE
DEPENDS ON STATUTE
NONE
NONE
STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE
STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE
STATUTORY DISSOLUTION
DEPENDS ON STATUTE, MOST ARE THE SAME AS FOR A LIMITED PARTNERSHIP
NONE
YES
YES, BUT RESTRICTIONS DESIRABLE YES
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
NO
NO
NO
NO
NO
(PARTNERSHIP / LLC AGREEMENTS MAY PROVIDE OTHERWISE) TRANSFERABILITY OF INTERESTS IN ENTITY ARE ANNUAL ELECTIONS OF DIRECTORS, MANAGERS, AND OFFICERS REQUIRED
YES
YES
12
FEDERAL AND PENNSYLVANIA INCOME TAX CONSEQUENCES OF STATE ENTITY CONVERSIONS
LP TO LLC AND LLC TO LP
CORPORATION TO LLC AND LLC TO CORPORATION
LP TO LLC
LLC TO LP – WILL BE VERY RARE
GENERALLY A CONVERSION FROM AN LP TO AN LLC WILL NOT BE TAXABLE TO THE LIMITED PARTNERS. LIMITED PARTNERS WILL HAVE A TAX BASIS FOR THEIR MEMBERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS, PLUS THEIR SHARE OF THE LLC’S RECOURSE DEBT. THE GENERAL PARTNER’S BASIS FOR ITS MEMBERSHIP INTEREST WILL DECREASE BY THE OTHER MEMBER’S SHARE OF THE LLC’S RECOURSE DEBT. THE GENERAL PARTNER COULD RECOGNIZE GAIN IF THERE IS A DECREASE IN ITS SHARE OF LIABILITIES AND THE DECREASE EXCEEDS THE PARTNER'S BASIS FOR ITS PARTNERSHIP INTEREST. THE LLC'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LP HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE PARTNERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES.
GENERALLY CONVERSION FROM AN LLC TO AN LP WILL NOT BE TAXABLE TO THE LLC MEMBERS. THE LIMITED PARTNERS WILL HAVE A BASIS FOR THEIR LIMITED PARTNERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LP’S RECOURSE DEBT. THE GENERAL PARTNER WILL HAVE A BASIS FOR ITS GENERAL PARTNERSHIP INTEREST EQUAL TO ITS BASIS FOR ITS MEMBERSHIP INTEREST PLUS THE OTHER MEMBER’S SHARE OF THE RECOURSE DEBT. THE LP'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LLC HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE MEMBERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES.
CORPORATION TO LLC – WILL BE VERY RARE
LLC TO CORPORATION
THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE MEMBERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR MEMBERSHIP INTERESTS. THE LLC WILL HAVE A FAIR MARKET VALUE BASIS FOR ITS ASSETS. FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS.
THE CONVERSION WILL BE TAX-FREE UNLESS THE LLC’S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE CORPORATION’S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE LLC HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LLC’S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE LLC’S DEBT EXCEEDS THEIR BASIS FOR THEIR MEMBERSHIP INTEREST.
13
CORPORATION TO LP AND LP TO CORPORATION
CORPORATION TO LP – WILL BE VERY RARE
LP TO CORPORATION
THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE PARTNERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR PARTNERSHIP INTERESTS PLUS THEIR SHARE OF THE PARTNERSHIP’S NON RECOURSE DEBT. THE PARTNERSHIP WILL HAVE A BASIS FOR ITS ASSETS EQUAL TO THE FAIR MARKET VALUE OF THE ASSETS FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS.
THE CONVERSION WILL BE TAX-FREE UNLESS THE PARTNERSHIP’S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE PARTNERSHIP’S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE PARTNERSHIP HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS LESS THEIR SHARE OF THE PARTNERSHIP’S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE PARTNERSHIP’S DEBT EXCEEDS THEIR BASIS FOR THEIR PARTNERSHIP INTEREST.
14
15
Conversion of Entities under Pennsylvania Law William H. Clark, Jr. Drinker Biddle & Reath LLP One Logan Square Philadelphia, PA 19103 (215) 988-2804 [email protected]
16
• Since July 1, 2015, Pennsylvania has authorized the conversion of entities from one form to another. • The conversion provisions are found in 15 Pa.C.S. Subch. 3E and are part of a complete set of inter-entity transaction provisions. • The provisions of 15 Pa.C.S. Ch. 3 apply to transactions involving only Pennsylvania entities and also those involving an entity organized under the law of a foreign jurisdiction that permits inter-entity transactions. 16
17
conversion (I) (single state)
L.P. A (PA)
LLC A (PA)
18
conversion (II) (multi-state)
L.P. A (DE)
LLC A (PA)
19
The only trick to using the new provisions is learning a new vocabulary: – – – – – – – –
governor interest interest holder organic law organic rules private organic rules public organic record “entity” v. “association” 19
20
– Governor: a person by or under whose authority the powers of an association are exercised and under whose direction the activities and affairs of the association are managed pursuant to the organic law and organic rules of the association. For example: • director of a business corporation • manager of a manager-managed LLC • member of a member-managed LLC
20
21
– Interest: a share in a corporation for profit, a membership or share in a corporation not-for-profit, a governance interest, or a distributional interest. For example: • share in a business corporation • membership interest in an LLC
– Interest holder: a direct or record holder of an interest. For example: • shareholder of a business corporation • member of an LLC
21
22
– Organic law: the law of the jurisdiction of formation of an association governing its internal affairs. For example: • the Business Corporation Law of 1988 • the Limited Liability Company Law of 1994
– Organic rules: the public organic record and private organic rules of an association. For example: • articles and bylaws of a business corporation • certificate of formation and operating agreement of an LLC
22
23
– Private organic rules: the rules that govern the internal affairs of an association, are binding on all its interest holders and are not part of its public organic record, if any. For example • bylaws of a business corporation • operating agreement of an LLC
– Public organic record: the document the public filing of which by the department or a similar agency in another jurisdiction is required to form an association. For example: • articles of a business corporation • certificate of formation of an LLC 23
“entity” v. “association” • An “entity” is a domestic or foreign organization of a type whose organic law is found in Title 15. • In contrast, “association” is a broader term that includes any type of private organization, whether domestic or foreign. – A banking institution is an association but not an entity.
association
entity
24
25
• The definitions just discussed are found in 15 Pa.C.S. § 102. – Thus, they apply to all of Title 15 and all of the Pennsylvania business entity laws.
• Definitions applicable just to Chapter 3 relating to fundamental transactions appear in 15 Pa.C.S. § 312. – These definitions are mostly unremarkable and simply facilitate the wording of Chapter 3. – Three definitions are worth noting and will be discussed later: • “interest holder liability” • “protected agreement” • “protected governance agreement”
25
26
procedures generally • The statutory provisions for conversions parallel the provisions for other types of transactions under Ch. 3: – – – – – –
authorization of the transaction preparation of a plan approval of the plan by the governors and interest holders amendment or abandonment of the plan filing and effectiveness effect of the transaction
• Substantive approval requirements under current law continue unchanged. – These are collected in a separate Subchapter 3B and organized by type of entity. 26
27
• Note that the general rule in Pennsylvania is that approval of a fundamental transaction requires the affirmative vote of a majority of the votes cast (which excludes abstentions) at a meeting at which a quorum is present. • This is in marked contrast to Delaware where approval requires the affirmative vote of a majority of the outstanding interests. 27
28
dissenters rights • Dissenters rights are available for shareholders on a conversion. • Statutory dissenters rights are not available for interest holders in entities that are not business corporations.
• Contractual dissenter rights are available for interest holders in entities that are not business corporations. See 15 Pa.C.S. § 317. 28
29
special treatment • 15 Pa.C.S. § 329 permits a plan to classify interest holders into groups on a basis other than the class or series of interest that they hold and provide mandatory treatment for members of the group. • This “special treatment” will be respected if either: 1. the interest holders receiving special treatment have either: • a class vote, or • dissenters rights
2. a court of competent jurisdiction finds that the special treatment was undertaken in good faith, after reasonable deliberation and was in the best interest of the association.
30
protected agreements • The concept of a “protected agreement” or “protected governance agreement” provides transitional protection. • These concepts are defined in 15 Pa.C.S. § 312 as follows: “Protected agreement.” Either of the following: (1) A record evidencing indebtedness and any related agreement in effect on July 1, 2015. (2) A protected governance agreement. “Protected governance agreement.” Either of the following: (1) The organic rules of a domestic entity or foreign association in effect on July 1, 2015. (2) An agreement that is binding on any of the governors or interest holders of a domestic entity or foreign association on July 1, 2015.
31
• If such an agreement deals with a merger, the agreement is deemed to apply to a conversion. • The notion is that, if people contracted for special rules or protections in the event of a merger at a time when conversions were not authorized, they are deemed to have wanted the same special arrangements for a conversion. – Underlying the concept is a recognition that a conversion could previously have been accomplished by using a merger.
32
interest holder liability • Interest holder liability is defined in 15 Pa.C.S. § 312 and is personal liability for either: – a liability of an association as a result of being an interest holder; or – an obligation to contribute to the association imposed by the organic rules.
• A transaction must be approved by any person that will have interest holder liability following the transaction. 32
33
A
General Partnership
B
Corporation
A
B
General Partnership
A
B
General Partnership
Corporation
A
B
Corporation
33
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