Dividing a Multi-Member LLC into Multiple LLCs

Divisions under IRC Section 708(b)(2)(B) of multi-member LLCs taxed as partnerships can offer unique advantages and flexibility in certain circumstances. Although initially written for traditional partnerships, IRC Section 708(b)(2)(B) applies to multi-member LLCs that elect to be treated as partnerships for tax purposes. So, the guidance on partnership divisions applies equally to such LLCs.

Under IRC Section 708(b)(2)(B), “in the case of a division of a partnership into two or more partnerships, the resulting partnerships (other than any resulting partnership the members of which had an interest of 50 percent or less in the capital and profits of the prior partnership) shall, for purposes of this section, be considered a continuation of the prior partnership.” This rule, when applied to LLCs, means that if an LLC taxed as a partnership divides into two or more resulting LLCs, each new LLC will be considered a continuation of the original LLC if its members held a greater than 50% ownership interest in the original LLC before the division.

Qualifying as a continuation of the original LLC can be highly beneficial because the new LLC(s) inherit the original LLC’s tax attributes. These include:

• Transaction history such as carryover basis and depreciation, built in gains and losses
• Important tax elections such as adjusting basis on transfer of membership interests
• Avoidance of transaction costs that otherwise arise from restructuring in the absence of retention of the original LLC’s tax attributes

Practical Applications for Dividing Multi-Member LLCs

Dividing a multi-member LLC into two or more LLC has several practical applications.

• Isolating asset risks  Often an LLC is created as a single purpose entity (SPE) to isolate liability associated with one asset – say, certain rental property, from other commonly held assets.  Over time the LLC organized as an SPE may acquire other assets, diluting the benefit of an SPE. Dividing the original LLC into two or more LLCs – each holding a single asset – restores the goal of isolating risk associated with one asset from that associated with other assets.
• Isolating business risks  An LLC operating primarily in one line of business may have the opportunity to branch – or may have branched – into a second venture. Dividing the original LLC into two with the new LLC owning the second venture insulates the risks of the new and old lines of business from one another.
• Separating Members In other circumstances it may be the members decide it is desirable for certain members to pursue certain business opportunities separately from other members.

Example Scenarios of LLC Division Treatment

The primary quirk when dividing an LLC i under Section 708(b)(2)(B), is that any new LLCs resulting from the division (including the original LLC) will be treated as a continuation of the original LLC only if the members of that resulting LLC had a greater than 50% ownership interest in the original LLC.  Consider these two examples.

Example 1: Suppose A, B, C, and D are members of Original LLC, holding 30%, 30%, 25%, and 15% membership interests, respectively. Original LLC divides, with A and B remaining in the original LLC, while C and D become the members of the new LLC with a 60% and 40% interest, respectively. Since C and D held only a 40% interest in Original LLC before the division, the new LLC will not be treated as a continuation of original LLC.

Example 2: Assume the same facts as in Example 1, but B decides to join C and D in the new LLC with a lesser 5% interest while retaining a 25% interest in the original LLC alongside A. New LLC is now owned 5% by B, 57%% by C, and 38%% by D. Since B, C, and D together held 70% of the original LLC, the new LLC qualifies as a continuation of original LLC and will inherit the original LLC’s tax attributes, including any tax elections and transaction history. For example, if the two LLCs go forward with a transaction such as the sale of real property, the tax treatment will be as though a single LLC was engaging in the sale.

Methods for Effectuating LLC Divisions

Treasury Regulations Section 1.708-1(d)(3)(i) describes the “assets-over form” as the default form for such divisions. In this form, original LLC is deemed to contribute property to new LLC in exchange for an interest in new LLC. It then distributes that interest to departing members in partial or complete liquidation of their membership interests. In Example 2, original LLC would contribute property to new LLC and then distribute new LLC’s membership interest to B, C, and D, fully liquidating the interest of C and D in original LLC, and partially liquidating the interest of B.

Reporting Requirements and EINs in LLC Divisions

In a division resulting in continuing LLCs, the original LLC will retain its EIN, while each new, continuing LLC must obtain a new EIN. The original LLC must file a return listing the names and contact information of the new LLCs, while each new LLC must file its own tax return, providing similar information about the original LLC.

While dividing a multi-member LLC taxed as partnership into multiple LLCs under IRC Section 708(b)(2)(B) has several practical and beneficial applications, the rules are a bit idiosyncratic. If this is something your LLC is considering it is best approached in close consultation with one’s tax advisors and counsel working collaboratively.