Treatment of Changes in Elective Entity Classification

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 8844]

RIN 1545-AV16

Treatment of Changes in Elective Entity Classification

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations describing how

elective changes in classification will be treated for federal tax

purposes. The final regulations affect business entities and their

members. The final regulations provide guidance to taxpayers who elect

to change an entity's classification for Federal tax purposes.

DATES: Effective Date: These regulations are effective November 29,

1999.

Applicability Dates: These regulations apply on or after November

29, 1999. However, taxpayers may choose to apply certain provisions in

these regulations before November 29, 1999 as specified in

Sec. 301.7701-2(e) and Sec. 301.7701-3(g)(4).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Dan

Carmody, (202) 622-3080 (not a toll-free number); concerning

international issues, Mark Harris, (202) 622-3860 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background

On October 28, 1997, proposed amendments to the regulations under

Secs. 301.6109-1, 301.7701-2, and 301.7701-3 [REG-105162-97] were

published in the Federal Register (62 FR 55768). A number of comments

were received on the proposed regulations. The public hearing scheduled

for February 24, 1998, was canceled because no one requested to speak.

After considering the submitted comments, the IRS and Treasury adopt

the proposed amendments to the regulations under Secs. 301.6109-1,

301.7701-2, and 301.7701-3 as revised by this Treasury decision.

Explanation of Provisions

I. Characterization of Elective Changes in Classification

There are four possible changes in classification of an eligible

entity by election under Sec. 301.7701-3: (i) A partnership elects to

be an association taxable as a corporation (association); (ii) an

association elects to be a partnership; (iii) an association elects to

be disregarded as an entity separate from its owner (disregarded

entity); and (iv) a disregarded entity elects to be an association. The

proposed regulations provide a form that each elective conversion would

be treated as having for federal tax purposes. Under the proposed

regulations, there is only one form for each elective conversion, and

taxpayers could not elect to have a different form apply to the

elective conversion.

A. Elective Conversions Treated as Having One Form

Commentators recommended that taxpayers be allowed to choose which

form to apply to an elective conversion. This would allow taxpayers to

avoid having to take the actual steps of a conversion to produce the

most favorable tax results. A commentator suggested that the lack of

choice in the proposed regulations is inconsistent with the intent of

the check-the-box regulations, which adopted an elective regime for

classifying eligible entities.

Because elective conversions are transactions without actual form,

the IRS and Treasury believe that it is appropriate to provide that

only one transaction form will be applied to each type of elective

conversion. Furthermore, while the check-the-box regulations provide an

elective regime for classifying eligible entities, the elective regime

was not intended to substitute for actual transactions in all

situations. Instead, the purpose of implementing the regime was to

simplify an area of the law where legal distinctions previously drawn

in determining an entity's classification were no longer meaningful.

While the factors considered under prior law did not meaningfully

distinguish between business organizations, taxpayers still were

required to expend considerable resources to ensure that they obtained

the classification they desired. Small business organizations often

lacked the resources and expertise to achieve their desired tax

classification. This was viewed as unfair.

The IRS was also expending considerable resources providing

guidance on these classification issues. These same concerns generally

are not

[[Page 66581]]

present in determining the form of a conversion transaction. Therefore,

the final regulations maintain only one form for each type of elective

conversion.

B. Form of Conversion From Association to Partnership

The proposed regulations provide that an elective conversion of an

association to a partnership is deemed to have the following form: The

association distributes all of its assets and liabilities to its

shareholders in liquidation of the association, and immediately

thereafter, the shareholders contribute all of the distributed assets

and liabilities to a newly formed partnership.

A commentator suggested that the proposed form for an elective

conversion of an association to a partnership may not minimize the tax

consequences of such a conversion under certain circumstances. The

commentator suggested that the proposed form should be available as an

election, but that the default form should be a deemed transfer of

assets and liabilities from the electing corporation to a newly formed

partnership for interests in the partnership followed immediately by a

liquidation of the electing corporation.

The IRS and Treasury believe that under current law a voluntary

formless change from an association to a partnership should be treated

as a liquidation of the corporation followed by a contribution of

assets to the partnership. See Rev. Rul. 63-107 (1963-2 C.B. 71).

Moreover, if the assets were deemed contributed by the electing

corporation to the partnership for partnership interests followed by a

liquidation of the corporation, the application of section 704(c)

(contribution of appreciated property), section 708 (partnership

termination), and section 754 (elective adjustments to the basis of

partnership assets) could be somewhat complex and difficult for

taxpayers and the IRS to administer. Therefore, the proposed form for

the elective conversion of an association to a partnership is adopted

without change.

C. Timing of Elective Changes in Classification

The proposed regulations provide that a classification election

takes effect at the start of the day for which the election is

effective. Any transactions that are deemed to occur because of a

change in classification are treated as occurring immediately before

the close of the day before the effective date of the election. The

owners of the entity when the election is effective may be different

from the owners of the entity when the conversion transactions are

deemed to occur. To ensure that the taxpayers who recognize the tax

consequences of a conversion election approve of the election, the

proposed regulations require that the election be signed by every owner

on the date of the deemed conversion transactions.

A commentator indicated that purchasers who wish to make a

classification election effective as of their first day of ownership

may endure a burden in obtaining the consents of previous owners. The

commentator recommended that the deemed conversion transactions be

treated as occurring at the start of the day for which the election is

effective, eliminating the need to obtain the consent of prior owners.

Under this suggestion, purchasers of an association who wish to elect

partnership treatment effective as of the first day of ownership would

be treated as owning both stock and partnership interests on that first

day of ownership. This would result in the purchasers being responsible

for a corporate return for their transitory period of corporate

ownership. See Sec. 1.6012-2.

The IRS and Treasury intended that the proposed timing rule

generally would be beneficial for taxpayers. The IRS and Treasury

believe that any burden imposed by this rule is outweighed by the

transactional flexibility that this rule provides. Accordingly, the

suggested change to the timing rule is not adopted.

Another commentator noted a conflict between the proposed timing

rule and the deemed transactions under section 338. Section 338 allows

a purchasing corporation to treat its stock purchase of another

corporation as an asset purchase. Under section 338, a purchasing

corporation may elect to treat the target corporation as: (1) Selling

its assets at fair market value on the acquisition date, and (2) a new

corporation that purchased all of the assets at the beginning of the

day after the acquisition date. If the purchaser also makes a

classification election for the target effective for the purchaser's

first day of ownership, the timing of the deemed liquidation under

Sec. 301.7701-3(g)(1) would conflict with the timing of the deemed

transactions required by section 338.

To address the issue, the final regulations specify that if section

338 applies, an election to convert the target corporation's

classification cannot be effective before the day after the acquisition

date of the target corporation. Additionally, the deemed liquidation

and conversion under Sec. 301.7701-3(g)(1) will occur immediately after

the completion of the section 338 transactions. These rules follow the

approach of Sec. 1.338-2(c)(1)(i), which provides that when a target

corporation liquidates on the acquisition date, the liquidation is

treated as occurring on the following day and immediately after the

deemed purchase of assets. If a taxpayer makes an election under

section 338 (without a section 338(h)(10) election) regarding a target

corporation that is subsequently deemed liquidated under these final

regulations, the target corporation must file a final or deemed sale

return as a C corporation reflecting the deemed sale. See Sec. 1.338-

1(e).

Commentators also expressed concern over the effect the proposed

timing rule would have on a sequence of elections when a number of

corporations are owned through a single ownership chain. If the

elections are all effective for the same date, the effect of the

interaction of the timing rule with section 332 is unclear. For

example, P corporation owns 100 percent of the interest of an eligible

entity classified as an association (S1), which owns directly 100

percent of the interest of an eligible entity classified as an

association (S2). P wants to convert S1 and S2 to disregarded entities

on the same day; however, if both deemed liquidations are treated as

occurring simultaneously, it is not clear that section 332

nonrecognition treatment would be available for both liquidations. The

final regulations clarify that in such a situation, unless another

order is specified for the elections, S1 will be treated as liquidating

into P immediately before S2 liquidates into P.

Commentators suggested that this situation could be addressed by

allowing taxpayers to make elections effective by the hour, instead of

only at the start of the day. The IRS and Treasury believe that the

clarification in the final regulations appropriately addresses the

treatment of successive elections. Therefore, the final regulations

maintain the rule that conversion elections take effect at the start of

the day on which the election is effective.

II. Taxpayer Identifying Numbers and Disregarded Entities

The proposed regulations provide clarification of the rules

regarding taxpayer identifying numbers (TINs). The proposed regulations

restate the rule that when an entity's classification changes under

Sec. 301.7701-3, it retains its employer identification number (EIN).

The proposed regulations also clarified the rule that a disregarded

entity must use its owner's TIN for

[[Page 66582]]

federal tax purposes. Furthermore, when a disregarded entity becomes

respected as a separate entity, it must use its own EIN and not the TIN

of the single owner.

One commentator asked for clarification regarding the use of TINs

and EINs in the proposed regulations. TINs include EINs, social

security numbers (SSNs), and IRS individual taxpayer identification

numbers (ITINs). The regulations require that a disregarded entity

report under the owner's TIN. The regulations refer to a taxpayer's TIN

because the term TIN encompasses not only an EIN, but also an SSN and

an ITIN.

Another commentator suggested that the proposed regulations were

too restrictive and prohibited a disregarded entity from applying for

and receiving its own TIN. The regulations do not prevent a single

member disregarded entity from applying for and receiving its own TIN.

The regulations merely provide that, except as otherwise provided in

regulations or other guidance, the single owner disregarded entity must

use the owner's TIN for federal tax purposes and not the EIN of the

disregarded entity. Notice 99-6 (1999-3 I.R.B. 1) provides guidance on

the limited circumstances under which a disregarded entity may use its

own EIN.

III. Rules for Foreign Entities

These final regulations also contain rules relating to certain

foreign entities.

A. Foreign Per Se Entities

The final check-the-box regulations provided a list of the names of

certain foreign business entities that are treated as corporations for

federal tax purposes. In response to comments from taxpayers, the

proposed regulations clarified those provisions. Specifically,

clarifications were made with respect to certain business entities

formed in Finland, Malaysia, Malta, Mexico, and Norway. These final

regulations adopt the proposed regulation's clarifications.

These final regulations also clarify the treatment of an entity

formed in Trinidad and Tobago that is specified in the final check-the-

box regulations. Prior to April 1997, Trinidad and Tobago's Companies

Act distinguished between public and private limited companies.

Effective April 1997, Trinidad and Tobago's Companies Act was amended

and now only provides for limited companies (and no longer provides for

private limited companies). Accordingly, these final regulations have

been modified to take into account that change. The effective date of

these final regulations with regard to an entity formed in Trinidad and

Tobago has been modified so as not to disadvantage taxpayers who relied

on the final check-the-box regulations. These final regulations provide

that the rule with regard to an entity formed in Trinidad and Tobago

will be effective on or after November 29, 1999. Accordingly, this rule

only affects those entities which were formed (or made affirmative

elections) on or after November 29, 1999.

These regulations also clarify the exception to per se corporate

treatment for Canadian companies and corporations. When the final

check-the-box regulations were promulgated, the only company or

corporation that could be formed where the liability of all of its

members was unlimited pursuant to any federal or provincial statute (as

opposed to through side agreements of the members), was a Nova Scotia

Unlimited Liability Company (NSULC). However, in order to avoid

changing the regulations if any other province, or the federal

government, subsequently allowed for the formation of unlimited

liability companies by statute, these regulations did not specifically

list the NSULC. In response to questions from taxpayers, the regulation

is clarified, with effect from January 1, 1997, by specifically naming

the NSULC, while still providing for any other unlimited liability

company that might subsequently be allowed by any other federal or

provincial statute.

B. Foreign Eligible Entities

Proposed regulations that provide a special rule for certain

foreign eligible entities are published elsewhere in this issue of the

Federal Register. In addition, the IRS and Treasury are still studying

what, if any, consequences occur when a foreign eligible entity that is

not relevant for federal tax purposes files an entity classification

election. The IRS and Treasury continue to request comments on this

topic.

IV. Changes in Number of Members of an Entity

The proposed regulations provide that an entity's classification

may change as a result of a change in the number of its members.

Specifically, an eligible entity classified as a partnership will

become a disregarded entity when the entity's membership is reduced to

one member, and a disregarded entity will be classified as a

partnership when the entity has more than one member. The final

regulations adopt these provisions without substantive change. Guidance

on the federal tax consequences of such changes has been provided in

Rev. Rul. 99-5 (1999-6 I.R.B. 8) and Rev. Rul. 99-6 (1999-6 I.R.B. 6).

Effective Date

These regulations are applicable on or after November 29, 1999. In

response to comments, however, the final regulations include a

provision allowing taxpayers to apply the regulations retroactively for

elective entity conversions that occurred before November 29, 1999.

Taxpayers may apply the final regulations retroactively only if all

taxpayers involved in the transaction follow the regulations. The rules

contained in Sec. 301.6109-1(h) are applicable as of January 1, 1997.

Certain changes to Sec. 301.7701-2(b)(8) may be applied before the

effective date as specified in Sec. 301.7701-2(e).

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in Executive Order 12866.

Therefore, a regulatory assessment is not required. It also has been

determined that section 553(b) of the Administrative Procedure Act (5

U.S.C. chapter 5) does not apply to these regulations, and because

these regulations do not impose a collection of information on small

entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not

apply. Therefore, a Regulatory Flexibility Analysis is not required.

Pursuant to section 7805(f) of the Internal Revenue Code, the notice of

proposed rulemaking preceding these regulations was submitted to the

Chief Counsel for Advocacy of the Small Business Administration for

comment on its impact on small business.

Drafting Information

The principal authors of these regulations are Dan Carmody and Jeff

Erickson, Office of Chief Counsel (Passthroughs and Special Industries)

and Mark Harris and Philip Tretiak, Office of Associate Chief Counsel

(International). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects in 26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

[[Page 66583]]

PART 301--PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read

in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 301.6109-1 is amended as follows:

1. Paragraph (d)(2)(ii) is removed and reserved.

2. Paragraph (h) is redesignated as paragraph (i) and the first

sentence of newly designated paragraph (i)(1) is amended by removing

the language ``paragraph (h)'' and adding ``paragraph (i)'' in its

place.

3. A new paragraph (h) is added.

The addition reads as follows:

Sec. 301.6109-1 Identifying numbers.

* * * * *

(h) Special rules for certain entities under Sec. 301.7701-3--(1)

General rule. Any entity that has an employer identification number

(EIN) will retain that EIN if its federal tax classification changes

under Sec. 301.7701-3.

(2) Special rules for entities that are disregarded as entities

separate from their owners--(i) When an entity becomes disregarded as

an entity separate from its owner. Except as otherwise provided in

regulations or other guidance, a single owner entity that is

disregarded as an entity separate from its owner under Sec. 301.7701-3,

must use its owner's taxpayer identifying number (TIN) for federal tax

purposes.

(ii) When an entity that was disregarded as an entity separate from

its owner becomes recognized as a separate entity. If a single owner

entity's classification changes so that it is recognized as a separate

entity for federal tax purposes, and that entity had an EIN, then the

entity must use that EIN and not the TIN of the single owner. If the

entity did not already have its own EIN, then the entity must acquire

an EIN and not use the TIN of the single owner.

(3) Effective date. The rules of this paragraph (h) are applicable

as of January 1, 1997.

* * * * *

Par. 3. Section 301.7701-2 is amended as follows:

1. Paragraph (b)(8)(i) is amended by revising the entries for

Finland, Malta, Norway, and Trinidad and Tobago.

2. Paragraph (b)(8)(ii)(A) is redesignated as paragraph

(b)(8)(ii)(A)(1) and revised.

3. Paragraph (b)(8)(ii)(B) is redesignated as paragraph

(b)(8)(ii)(A)(2).

4. Paragraph (b)(8)(ii) heading and introductory text are

redesignated as paragraph (b)(8)(ii)(A) heading and introductory text,

and a new paragraph heading is added for paragraph (b)(8)(ii).

5. Paragraphs (b)(8)(ii)(A)(3) and (b)(8)(ii)(B) are added.

6. Paragraphs (b)(8)(iii), (b)(8)(iv), and (e) are revised.

The revisions and additions read as follows:

Sec. 301.7701-2 Business entities; definitions.

* * * * *

(b) * * *

(8) * * *

(i) * * *

Finland, Julkinen Osakeyhtio/Publikt Aktiebolag

* * * * *

Malta, Public Limited Company

* * * * *

Norway, Allment Aksjeselskap

* * * * *

Trinidad and Tobago, Limited Company

* * * * *

(ii) Clarification of list of corporations in paragraph (b)(8)(i)

of this section--(A) Exceptions in certain cases. * * *

* * * * *

(1) With regard to Canada, a Nova Scotia Unlimited Liability

Company (or any other company or corporation all of whose owners have

unlimited liability pursuant to federal or provincial law).

* * * * *

(3) With regard to Malaysia, a Sendirian Berhad.

(B) Inclusions in certain cases. With regard to Mexico, the term

Sociedad Anonima includes a Sociedad Anonima that chooses to apply the

variable capital provision of Mexican corporate law (Sociedad Anonima

de Capital Variable).

(iii) Public companies. For purposes of paragraph (b)(8)(i) of this

section, with regard to Cyprus, Hong Kong, and Jamaica, the term Public

Limited Company includes any Limited Company that is not defined as a

private company under the corporate laws of those jurisdictions. In all

other cases, where the term Public Limited Company is not defined, that

term shall include any Limited Company defined as a public company

under the corporate laws of the relevant jurisdiction.

(iv) Limited companies. For purposes of this paragraph (b)(8), any

reference to a Limited Company includes, as the case may be, companies

limited by shares and companies limited by guarantee.

* * * * *

(e) Effective date. Except as otherwise provided in this paragraph

(e), the rules of this section apply as of January 1, 1997. The

reference to the Finnish, Maltese, and Norwegian entities in paragraph

(b)(8)(i) of this section is applicable on November 29, 1999. The

reference to the Trinidadian entity in paragraph (b)(8)(i) of this

section applies to entities formed on or after November 29, 1999. Any

Maltese or Norwegian entity that becomes an eligible entity as a result

of paragraph (b)(8)(i) of this section in effect on November 29, 1999

may elect by February 14, 2000 to be classified for federal tax

purposes as an entity other than a corporation retroactive to any

period from and including January 1, 1997. Any Finnish entity that

becomes an eligible entity as a result of paragraph (b)(8)(i) of this

section in effect on November 29, 1999 may elect by February 14, 2000

to be classified for federal tax purposes as an entity other than a

corporation retroactive to any period from and including September 1,

1997.

Par. 4. Section 301.7701-3 is amended as follows:

1. A sentence is added at the end of paragraph (c)(1)(iii).

2. A sentence is added at the end of paragraph (c)(1)(iv).

3. Paragraph (c)(2)(iii) is added.

4. A heading is added to paragraph (d)(1).

5. Paragraph (f) is redesignated as paragraph (h) and newly

designated paragraph (h)(1) is revised.

6. Paragraphs (f) and (g) are added.

The revision and additions read as follows:

Sec. 301.7701-3 Classification of certain business entities.

* * * * *

(c) * * *

(1) * * *

(iii) Effective date of election. * * * If a purchasing corporation

makes an election under section 338 regarding an acquired subsidiary,

an election under paragraph (c)(1)(i) of this section for the acquired

subsidiary can be effective no earlier than the day after the

acquisition date (within the meaning of section 338(h)(2)).

(iv) Limitation. * * * An election by a newly formed eligible

entity that is effective on the date of formation is not considered a

change for purposes of this paragraph (c)(1)(iv).

* * * * *

(2) * * *

(iii) Changes in classification. For paragraph (c)(2)(i) of this

section, if an election under paragraph (c)(1)(i) of this section is

made to change the classification of an entity, each person

[[Page 66584]]

who was an owner on the date that any transactions under paragraph (g)

of this section are deemed to occur, and who is not an owner at the

time the election is filed, must also sign the election. This paragraph

(c)(2)(iii) applies to elections filed on or after November 29, 1999.

(d) Special rules for foreign eligible entities--(1) Definition of

relevance. * * *

* * * * *

(f) Changes in number of members of an entity--(1) Associations.

The classification of an eligible entity as an association is not

affected by any change in the number of members of the entity.

(2) Partnerships and single member entities. An eligible entity

classified as a partnership becomes disregarded as an entity separate

from its owner when the entity's membership is reduced to one member. A

single member entity disregarded as an entity separate from its owner

is classified as a partnership when the entity has more than one

member. If an elective classification change under paragraph (c) of

this section is effective at the same time as a membership change

described in this paragraph (f)(2), the deemed transactions in

paragraph (g) of this section resulting from the elective change

preempt the transactions that would result from the change in

membership.

(3) Effect on sixty month limitation. A change in the number of

members of an entity does not result in the creation of a new entity

for purposes of the sixty month limitation on elections under paragraph

(c)(1)(iv) of this section.

(4) Examples. The following examples illustrate the application of

this paragraph (f):

Example 1. A, a U.S. person, owns a domestic eligible entity

that is disregarded as an entity separate from its owner.

On January 1, 1998, B, a U.S. person, buys a 50 percent interest

in the entity from A. Under this paragraph (f), the entity is

classified as a partnership when B acquires an interest in the

entity. However, A and B elect to have the entity classified as an

association effective on January 1, 1998. Thus, B is treated as

buying shares of stock on January 1, 1998. (Under paragraph

(c)(1)(iv) of this section, this election is treated as a change in

classification so that the entity generally cannot change its

classification by election again during the sixty months succeeding

the effective date of the election.) Under paragraph (g)(1) of this

section, A is treated as contributing the assets and liabilities of

the entity to the newly formed association immediately before the

close of December 31, 1997. Because A does not retain control of the

association as required by section 351, A's contribution will be a

taxable event. Therefore, under section 1012, the association will

take a fair market value basis in the assets contributed by A, and A

will have a fair market value basis in the stock received. A will

have no additional gain upon the sale of stock to B, and B will have

a cost basis in the stock purchased from A.

Example 2. (i) On April 1, 1998, A and B, U.S. persons, form X,

a foreign eligible entity. X is treated as an association under the

default provisions of paragraph (b)(2)(i) of this section, and X

does not make an election to be classified as a partnership. A

subsequently purchases all of B's interest in X.

(ii) Under paragraph (f)(1) of this section, X continues to be

classified as an association. X, however, can subsequently elect to

be disregarded as an entity separate from A. The sixty month

limitation of paragraph (c)(1)(iv) of this section does not prevent

X from making an election because X has not made a prior election

under paragraph (c)(1)(i) of this section.

Example 3. (i) On April 1, 1998, A and B, U.S. persons, form X,

a foreign eligible entity. X is treated as an association under the

default provisions of paragraph (b)(2)(i) of this section, and X

does not make an election to be classified as a partnership. On

January 1, 1999, X elects to be classified as a partnership

effective on that date. Under the sixty month limitation of

paragraph (c)(1)(iv) of this section, X cannot elect to be

classified as an association until January 1, 2004 (i.e., sixty

months after the effective date of the election to be classified as

a partnership).

(ii) On June 1, 2000, A purchases all of B's interest in X.

After A's purchase of B's interest, X can no longer be classified as

a partnership because X has only one member. Under paragraph (f)(2)

of this section, X is disregarded as an entity separate from A when

A becomes the only member of X. X, however, is not treated as a new

entity for purposes of paragraph (c)(1)(iv) of this section. As a

result, the sixty month limitation of paragraph (c)(1)(iv) of this

section continues to apply to X, and X cannot elect to be classified

as an association until January 1, 2004 (i.e., sixty months after

January 1, 1999, the effective date of the election by X to be

classified as a partnership).

(5) Effective date. This paragraph (f) applies as of November 29,

1999.

(g) Elective changes in classification--(1) Deemed treatment of

elective change--(i) Partnership to association. If an eligible entity

classified as a partnership elects under paragraph (c)(1)(i) of this

section to be classified as an association, the following is deemed to

occur: The partnership contributes all of its assets and liabilities to

the association in exchange for stock in the association, and

immediately thereafter, the partnership liquidates by distributing the

stock of the association to its partners.

(ii) Association to partnership. If an eligible entity classified

as an association elects under paragraph (c)(1)(i) of this section to

be classified as a partnership, the following is deemed to occur: The

association distributes all of its assets and liabilities to its

shareholders in liquidation of the association, and immediately

thereafter, the shareholders contribute all of the distributed assets

and liabilities to a newly formed partnership.

(iii) Association to disregarded entity. If an eligible entity

classified as an association elects under paragraph (c)(1)(i) of this

section to be disregarded as an entity separate from its owner, the

following is deemed to occur: The association distributes all of its

assets and liabilities to its single owner in liquidation of the

association.

(iv) Disregarded entity to an association. If an eligible entity

that is disregarded as an entity separate from its owner elects under

paragraph (c)(1)(i) of this section to be classified as an association,

the following is deemed to occur: The owner of the eligible entity

contributes all of the assets and liabilities of the entity to the

association in exchange for stock of the association.

(2) Effect of elective changes. The tax treatment of a change in

the classification of an entity for federal tax purposes by election

under paragraph (c)(1)(i) of this section is determined under all

relevant provisions of the Internal Revenue Code and general principles

of tax law, including the step transaction doctrine.

(3) Timing of election--(i) In general. An election under paragraph

(c)(1)(i) of this section that changes the classification of an

eligible entity for federal tax purposes is treated as occurring at the

start of the day for which the election is effective. Any transactions

that are deemed to occur under this paragraph (g) as a result of a

change in classification are treated as occurring immediately before

the close of the day before the election is effective. For example, if

an election is made to change the classification of an entity from an

association to a partnership effective on January 1, the deemed

transactions specified in paragraph (g)(1)(ii) of this section

(including the liquidation of the association) are treated as occurring

immediately before the close of December 31 and must be reported by the

owners of the entity on December 31. Thus, the last day of the

association's taxable year will be December 31 and the first day of the

partnership's taxable year will be January 1.

(ii) Coordination with section 338 election. A purchasing

corporation that makes a qualified stock purchase of an eligible entity

taxed as a corporation may make an election under section 338 regarding

the acquisition if it satisfies

[[Page 66585]]

the requirements for the election, and may also make an election to

change the classification of the target corporation. If a taxpayer

makes an election under section 338 regarding its acquisition of

another entity taxable as a corporation and makes an election under

paragraph (c) of this section for the acquired corporation (effective

at the earliest possible date as provided by paragraph (c)(1)(iii) of

this section), the transactions under paragraph (g) of this section are

deemed to occur immediately after the deemed asset purchase by the new

target corporation under section 338.

(iii) Application to successive elections in tiered situations.

When elections under paragraph (c)(1)(i) of this section for a series

of tiered entities are effective on the same date, the eligible

entities may specify the order of the elections on Form 8832. If no

order is specified for the elections, any transactions that are deemed

to occur in this paragraph (g) as a result of the classification change

will be treated as occurring first for the highest tier entity's

classification change, then for the next highest tier entity's

classification change, and so forth down the chain of entities until

all the transactions under this paragraph (g) have occurred. For

example, Parent, a corporation, wholly owns all of the interest of an

eligible entity classified as an association (S1), which wholly owns

another eligible entity classified as an association (S2), which wholly

owns another eligible entity classified as an association (S3).

Elections under paragraph (c)(1)(i) of this section are filed to

classify S1, S2, and S3 each as disregarded as an entity separate from

its owner effective on the same day. If no order is specified for the

elections, the following transactions are deemed to occur under this

paragraph (g) as a result of the elections, with each successive

transaction occurring on the same day immediately after the preceding

transaction S1 is treated as liquidating into Parent, then S2 is

treated as liquidating into Parent, and finally S3 is treated as

liquidating into Parent.

(4) Effective date. This paragraph (g) applies to elections that

are filed on or after November 29, 1999. Taxpayers may apply this

paragraph (g) retroactively to elections filed before November 29, 1999

if all taxpayers affected by the deemed transactions file consistently

with this paragraph (g).

(h) Effective date--(1) In general. Except as otherwise provided in

this section, the rules of this section are applicable as of January 1,

1997.

* * * * *

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

Approved: November 2, 1999.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury (Tax Policy).

[FR Doc. 99-30504 Filed 11-26-99; 8:45 am]

BILLING CODE 4830-01-U