LLC Conversions: Utilizing IRC Section 351 for Tax-Free Exchanges

IRC Section 351 allows for the tax-free transfer of property to a corporation in exchange for stock, provided certain requirements—most notably, control—are satisfied. Revenue Ruling 84-111 outlines the three permissible methods for converting an LLC into a corporation: Assets Over, Assets Up, and Interests Over. Each method has distinct legal mechanics but aims to achieve the same result: a tax-free incorporation.

Converting an LLC to a C corp is often necessary for fundraising or achieving QSBS eligibility. However, significant tax traps exist, including failures of the control test, debt in excess of basis under Section 357(c), issuance of nonqualified preferred stock (NQPS), and missteps with Section 83(b) elections. Service providers with unvested equity and holders of convertible debt, SAFEs, or warrants face additional tax complexity.

Understanding the technical and practical issues involved in LLC-to-C corp conversions is crucial for business owners, tax professionals, and advisors looking to avoid unintended tax consequences and maximize long-term tax benefits like QSBS.

Listen as our panel of federal income tax professionals explains the key considerations, requirements, and examples of how to navigate LLC conversions under Section 351.

I. Introduction to LLC Conversions

A. Why convert?

B. Legal and tax objectives

II. Rev. Rul. 84-111: Permitted Methods of Conversion

A. Assets Over

B. Assets Up

C. Interests Over

III. Requirements for Tax-Free Treatment Under Section 351

A. Property transferred

B. Stock received

C. Control under Section 368(c)

D. Business purpose

IV. Common Traps and Taxable Transactions

A. Failing the 80% control test

B. Section 357(c): debt in excess of basis

C. Issuance of nonqualified preferred stock

D. Negative capital accounts

E. Missed Section 83(b) elections

F. Treatment of unvested interests and service equity

V. Special Equity and Investment Considerations

A. Profits interests and liquidation preferences

B. Treatment of options and conversion math

C. SAFEs, investment warrants, and convertible debt

VI. QSBS and Section 1244 Implications

A. Requirements for QSBS eligibility

B. Holding period and $50M test

C. Stock received in conversions

D. Section 1244 stock limitations

VII. Examples and Scenarios

A. State-filed conversion

B. SAFE exchange implications

C. Treatment of profits interests in conversion

The panel will cover these and other critical issues:

• Understanding the “Assets Over,” “Assets Up,” and “Interests Over” conversion methods
• Meeting the control and property tests under Section 351
• Avoiding hidden tax traps like Section 357(c), NQPS, and missed 83(b) elections
• Planning for QSBS eligibility and preserving tax-free treatment
• Converting service provider equity and structuring replacement options

Learning Objectives

After completing this course, you will be able to:

• Identify exchanges that qualify for tax-free treatment under Section 351
• Determine what constitutes qualifying property in a Section 351 transaction
• Decide when taxpayers could benefit from a Section 351 exchange
• Ascertain potential missteps that could negate Section 351 tax-free treatment

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite:

  Three years+ business or public firm experience preparing complex tax forms and schedules, supervising other preparers or accountants. Specific knowledge and understanding of pass-through taxation, including taxation of partnerships, S corporations and their respective partners and shareholders.

  
  

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Strafford is an IRS-approved continuing education provider offering certified courses for Enrolled Agents (EA) and Tax Return Preparers (RTRP).