A “99-5” is a reference to IRS Revenue Ruling 99-5 that outlines the tax implications of federal income of a transaction taking place when an LLC with a single member (the limited company with a liability) to a partnership for federal taxes.
Before we discuss the process and the guidelines that RR 99-5 provides, Let us look at the differences between the sole proprietorship LLC and the C-corporation. The sole proprietor doesn’t have to file the legal documents necessary to create an LLC or start an independent business if they plan to operate independently. But, you aren’t able to take on the responsibility of ownership and will likely require a license for business in many instances. However, the disadvantage is that you’re still responsible for the company’s obligations, and this risk could be substantial.
A Limited Liability Corporation allows you to increase the number of shareholders you have in the future or the near future. The structure also gives you more flexibility as you expand. In addition, you are able to shield yourself from risk because you’re not personally subject to the risk of business debts. Because LLCs are an easy business structure, it is popular among entrepreneurs with small businesses, which include real property investors. Taxation through federal pass-through is one of the benefits of being the LLC owner.
However, a C Corporation might be a sensible option if you’re planning on more extensive expansion. It has the potential to go public if it’s an option C Corporations are well-known internationally. Furthermore, this form of organization, similar to the LLC, protects owners from being held liable. However, the company and shareholders are taxed on earnings, and you lose flexibility when you have an executive board.
If A Single-Member LLC Becomes Multi-Member LLC
Suppose the company is an LLC and the sole proprietor plans to recruit another member or additional participants. Revenue Ruling, 99-5, gives IRS guidelines on the proper accounting practices for the change, based on whether the new participant is joining by donating cash, property, or both.
The IRS guidance discusses the scenarios that the original LLC (owned by a single member A) becomes a co-ownership due to member B buying shares within the LLC from A, who keeps the money contributed to use as they please or by donating funds to the LLC the funds for exchange of a portion of ownership. However, the money is used to fund the LLC’s operating capital. RR 99-5 states that in both situations, there is no choice of entity classification made to consider an LLC like an entity.
The initial owner’s decision on whether to exchange an interest in exchange for cash or permit an unrelated participant to donate the property or money in exchange for interest will likely be determined by the owner of the interest who wants an increase in personal income or more cash flow to fund operations for the company.
Similar Revenue Ruling 99-6
In the reverse case, the multi-member LLC could be transformed into a single-owner LLC if the owners all sell their shares to a single owner. The person could comprise one of the owners currently or be a non-owner who is presently a member. The guidelines given by the IRS to facilitate this type of transaction are found in the Revenue Ruling 99-6.
