what are tax implications when partnership LLC becomes a Subsidiary (and disregarded entity)

[z93007]

Assume Company ABC is registered as a partnership LLC (2 owners) and doing business for a few years. In the mid of a year, co. PQR buys co. ABC and thus owns it fully (100% of it). Note that PQR is also a registered partnership LLC.

Now, the subsidiary co. ABC becomes a disregarded entity and all the income/expenses etc. will be reported by co. PQR. 

The CPA thinks this makes ABC a single-member LLC because it is owned by one parent co., PQR. He suggests adding one of the partners of PQR be given even a fraction of a % ownership of ABC so it will look like ABC is owned by two partners, the new person who is given some % (let's say 1%) and PQR (which now own 99%).

He says this will help avoid IRS tax treatment of disregarded entities and need to pay some tax penalties as we did not report the change of status from partnership to disregarded in August when acquisition happened)

I understand that "If the LLC is deemed a disregarded entity, in the eyes of the IRS, your LLC is not taxed as an entity separate from you, the owner." But in this case, the owner is another partnership LLC. 

So I am not clear. do we still need to add another partner with just a fraction of ownership to make it look like ABC is owned by two different entities? 

After all, the acquisition is nothing new.  There are many acquisitions happening in business,. Not sure if in these acquisitions they show it as owned by the holding (acquiring) company as well as another entity to make it a partnership.  

Has anyone any clarification on the tax treatment of PQR. IS giving some small % to another person necessary to make it look like it is a partnership? 

Thank you in advance. 

- Z

[AliciaP1 · Accepted solution]

No, there does not need to be another partner.  PQR as a partnership can own ABC and should report it as a division of PQR on the 1065 of PQR.

Per the IRS:

If the single-member LLC is owned by a corporation or partnership, the LLC should be reflected on its owner's federal tax return as a division of the corporation or partnership.

See Single Member Limited Liability Companies for more information.

[z93007]

Alicia,

Thank you so much for your reply and the related link. It really helps to clarify. (I will pass it on to the CPA) 

Meanwhile, a quick question. 

1. Do we need to update IRS if the status of ABC changed from a partnership to a disregarded entity in the middle of the year when the ownership changed?

2. Is there a penalty for informing IRS about this later and not immediately?

Thank you,

[AliciaP1]

No, no special notification needs to go out except the partnership return for ABC will be filed as final due to the ownership change.  The partnership return should have been filed by the 15th of the 3rd month after the partnership's tax year ended. 

So, if the sale happened on 5/31/21, for example, the return with the final return notification was due to be filed 8/15/21.  You may get a notification from the IRS about late filing, but as long as you file it by 3/15/22 (the calendar year due date) you likely will not get anything.

[z93007]

OK, this helps. So that 3-month window could be what the CPA be referring to about the late filing as the closing was on 8/1/21 and we haven't filed it yet (but plan to do it before 3/15/22). So hopefully, a notice from IRS but no penalty (keeping fingers crossed :).

Thank you so much for your kind help and clear answer. Much appreciated.