Prior to the wide-scale acceptance of limited liability companies (“LLC”), many business owners who wished to avoid a “double tax” on the income from their business turned to general partnerships. While that form of entity did generally avoid the double taxation of business income inherent in a corporation, the cost of doing so was to expose each partner to unlimited personal liability for the partnership’s debts, liabilities and obligations to the full extent of his personal assets.
While limited liability companies are not subject to double taxation of their income because of “pass through” tax treatment, unlike partners, the owners of a limited liability company—its members- are not personally liable for the LLC’s debts, liabilities or obligations solely by reason of their status as a member—so-called, vicarious liability. A member’s vicarious liability is typically limited to his contribution to the LLC, like a shareholder of a corporation.
This limited liability protection does not, however, protect a member from liabilities resulting from his own misconduct. Such a member will remain personally liable for any obligations and liabilities which result from his own wrongful conduct.
Because of the liability advantages of a limited liability company, many partners—troubled by the prospect of having their personal assets at risk for the obligations of their business– began to consider whether and how they could convert their partnerships into limited liability companies so as to avoid continued personal liability for the debts and obligations of their business.
At first, the conversion process in most states was nonexistent and/or cumbersome and few partnerships sought to restructure themselves as limited liability companies. However, as states began to recognize the need to allow partnerships to convert to limited liability companies in a simple and inexpensive way, they enacted legislation that facilitated and streamlined that process. In many states now, a general partnership can be restructured as an LLC by a simple filing with the state and payment of a filing fee. Following the conversion the former partners of the pre-conversion general partnership will not be personally liable for any debts and other obligations taken on by the entity after it becomes an LLC. However, they will still be personally liable for obligations incurred by the partnership prior to its conversion to an LLC.
Most states now provide that a pre-conversion partnership and post-conversion LLC will be regarded as the same legal entity for all purposes, and treat the LLC as an uninterrupted continuation of the pre-conversion partnership. Therefore, the conversion will not be treated as a transfer of assets and obligations by the partnership to the LLC, and the partnership’s assets and liabilities will automatically become the assets and obligations of the limited liability company. Since the conversion is not treated as a transfer, no third party consents will generally be necessary, nor in most instances will any transfer or recordation taxes be due on the conversion. Also, the LLC does not need to obtain a new Employer Identification Number (“EIN”). It can continue to use the EIN originally issued to the pre –conversion partnership. And for income tax purposes, as long as nothing changes in regard to the ownership percentages in the LLC of the former partners/members, the conversion to an LLC will generally not be treated as a taxable event; and, in most cases, no federal or state income taxes will be due from any of the partners of the pre- conversion partnership.
If you are currently a partner in a partnership, you should consider whether a conversion might be beneficial for you and your partners. For a no obligation consultation on converting your partnership contact Norman L. Eule, Esq. at 703-556-0411 or firstname.lastname@example.org.
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