Converting a Partnership to an LLC or an LLP

by Barbara Jo Smith

Fall 2000

Clark Williams' article explained many good reasons to use a limited liability company ("LLC") including limited liability for owners with the tax flexibility of a partnership. Professional partnerships have the option to convert to a limited liability partnership ("LLP") which has limited liability characteristics which are similar to those of an LLC.

Generally, partnerships can convert into an LLC or LLP without any adverse tax effects. In any business transition, however, it is important to analyze separately Oregon 's statutory law and the federal tax law.

Oregon Statutory Law

Oregon Legislation that became effective on January 1, 2000, allows many businesses to convert easily into other types of entities. For example, partnerships may convert to LLCs, if the partners unanimously adopt a plan of conversion. The plan can be a simple one page document as long as it includes the basic statutory requirements. Once the plan is approved, the partnership files Articles of Conversion with the Secretary of State's office. If the partnership owns real property, the partners should transfer it by deed to the LLC. The partners should also review the partnership agreement and revise it to reflect the fact that an LLC has "members" instead of "partners" and that the members are generally not liable for the debts of the LLC.

The LLP statute became effective in 1997. Unanimous agreement of the partners and the filing of an Application for Registration are all that is required. Again, a review of the partnership agreement is prudent because leaving it as is may take away the limited liabilities granted by statute. The limited liability features of an LLP will not shelter each partner from his or her own professional liabilities.

For both LLCs and LLPs it is important to let vendors and other creditors know about the conversion. The protection of limited liability will not apply to claimants who have not received notice of the conversion. Also, the limited liability protection will only apply to activities which occur after the Articles of Conversion or the Application for Registration are effective. General partners are still personally liable for all liabilities incurred prior to the conversion.

Federal Tax Law

Before a business changes its state law entity classification, the tax consequences should be carefully reviewed. For instance, using the new conversion statutes to change a corporation to an LLC will cause the corporation to be treated for tax purposes as if a liquidation occurred. Such a liquidation could trigger significant unintended tax consequences.

General partnerships, LLCs and LLPs are normally taxed as partnerships under federal and state income tax laws. For this reason, the IRS allows conversions from partnerships to LLCs and LLPs without affecting the tax status of the entity. Even if the conversion occurs in the middle of the year, the entity files a single tax return for the entire fiscal year and uses the same tax identification number.

The ownership percentages of the partners must carry through to the LLC. If the partners do not have the same share of the LLC after the conversion as they had in the partnership before the conversion, the change may be a deemed distribution, contribution or sale for tax purposes.

Conclusion

Every general, professional and limited partnership should consider converting to an LLC or an LLP. The benefit is limited liability for the partners without adverse tax consequences. Under the new Oregon laws, the conversion is relatively simple.