Treatment of Changes in Elective Entity Classification

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 301 [TD 8844] RIN 1545-AV16

TITLE: Treatment of Changes in Elective Entity Classification

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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
§301.7701-2(e) and §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
§§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 §§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 §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 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 §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 §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
§301.7701-3(g)(1) will occur immediately after the completion of the
section 338 transactions. These rules follow the approach of
§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
§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
§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 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 §301.6109-1(h) are applicable as of January
1, 1997. Certain changes to §301.7701-2(b)(8) may be applied before
the effective date as specified in §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:

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:

§301.6109-1 Identifying numbers. *

* * * *

(h) Special rules for certain entities under §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 §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 §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 is 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:

§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:

§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 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 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.

* * * * *

Deputy Commissioner of Internal Revenue
Approved:
Assistant Secretary of the Treasury
(Tax Policy)

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