Ownership interest in electing LLC is stock for tax purposes
No matter what its name or legal designation
TAX ALERT |
A recent IRS ruling illustrates a longstanding principle of U.S. tax rules—whether an instrument is treated as stock for tax purposes does not depend on the name written at the top of the legal instrument.
The taxpayers in PLR 201636003 sought a ruling that the corporate stock it had sold was qualified small business stock (QSB stock) under section 1202 of the Tax Code. Taxpayers who sell QSB stock at a gain can exclude 50 percent of that gain (sometimes 100 percent) from their taxable income, if certain requirements are met. Because the corporation had undergone a series of conversion transactions, the taxpayers wanted to make sure the stock they had sold could qualify for the gain exclusion.
The corporation had changed its name twice, then converted to a limited liability company (LLC) and elected to be treated as a corporation for tax purposes. Later, it converted from an LLC back to corporate legal form.
The IRS held that the stock the taxpayers had sold was QSB stock. The corporate name changes did not affect the ability of the stock to qualify as QSB stock. The fact that the corporation was for a period of time legally organized as an LLC and had equity interests not called stock for legal purposes did not preclude QSB stock treatment, since the equity of an LLC that has elected to be treated as a corporation is treated as corporate stock for federal income tax purposes. Finally, conversion of the LLC back to corporate form did not preclude QSB stock treatment for the stock issued to the taxpayers in the conversion, since stock received in exchange for QSB stock in a tax-free exchange may also qualify as QSB stock.
While this ruling addresses specific tax rules governing certain taxpayers selling small business stock, it illustrates a broader general principle. For federal tax purposes, stock ownership is a matter of economic substance. An instrument that carries the rights to management, profits and ultimately the assets of an entity treated as a corporation generally is stock, regardless of the legal name of the instrument.