Revenue Ruling Gives Guidance on S Elections for Partnerships Converting to Corporations

The IRS issued Revenue Ruling 2009-15, which addresses the question of whether, when a partnership becomes a corporation for federal tax purposes, it is eligible to elect to be taxed as an S corporation in its first tax year. The ruling, issued Thursday, clarifies that a partnership that converts to a corporation is eligible to make an S election, effective for the corporation’s first tax year.

The revenue ruling looks at two situations: The first is when a partnership elects under the check-the-box regulations to be taxed as an association. The second is when a partnership converts to a corporation under a state formless conversion statute. Under Rev. Rul. 2004-59, these two situations should be treated the same for federal tax purposes.

In the first situation, under Treas. Reg. § 301.7701-3, the following steps are deemed to occur: The partnership contributes all its assets and liabilities to the association in exchange for association stock and immediately the partnership liquidates by distributing the stock to its partners. Under these steps, the revenue ruling says, the partnership (which would be an ineligible S corporation shareholder) never owns the association stock during the association’s first tax year. Therefore, the association is eligible to elect S status in its first tax year.

In the second situation, the same steps are deemed to occur, except that instead of association stock, stock of a corporation is involved. But according to the revenue ruling, the results are the same: The partnership never owns the corporation stock during the corporation’s first tax year because it is deemed to have distributed it immediately to its partners. Therefore, the corporation is eligible to elect S status in its first year.

In addition, the corporation is not deemed to have had a short C corporation year preceding its first S year.