[Federal Register Volume 62, Number 208 (Tuesday, October 28, 1997)]
[Proposed Rules]
[Pages 55768-55773]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-28165]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-105162-97]
RIN-1545-AV16


Treatment of Changes in Elective Entity Classification

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations addressing 
elective changes in entity classification. The proposed regulations 
describe how elective changes in classification will be treated for 
federal tax purposes. The proposed regulations would affect business 
entities and their members. This document also contains a notice of 
public hearing on these proposed regulations.

DATES: Written comments must be received by January 26, 1998. Requests 
to speak (with outlines of oral comments) at the public hearing 
scheduled for February 24, 1997, must be submitted by January 26, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105162-97), room 
5228, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R 
(REG-105162-97), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue NW., Washington, DC. Alternatively, taxpayers may 
submit comments electronically via the Internet by selecting the ``Tax 
Regs'' option of the IRS Home Page, or by submitting comments directly 
to the IRS Internet site at: http://www.irs.ustreas.gov/prod/tax_regs/
comments.html. The public hearing will be held in room 2615, Internal 
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.


[[Page 55769]]


FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jeff 
Erickson, (202) 622-3070 (not a toll-free number); concerning 
international issues, Philip Tretiak or Ronald M. Gootzeit, (202) 622-
3860 (not a toll free number); concerning submissions and the hearing, 
Evangelista Lee, (202) 622-7190 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document proposes to amend the current Income Tax Regulations 
(26 CFR Parts 1 and 301) relating to the classification of entities for 
federal tax purposes. On December 18, 1996, the IRS and Treasury 
published final regulations under section 7701 (final regulations), 
replacing the former classification rules with an elective regime. See 
TD 8697 (1997-2 I.R.B. 11).
    Under the final regulations, a business entity that is not 
specifically classified as a corporation in the final regulations (an 
eligible entity) can elect its classification for federal tax purposes 
under certain circumstances. An eligible entity with at least two 
members can elect to be classified as a partnership or as an 
association taxable as a corporation. An eligible entity with a single 
member can elect to be classified as an association or as an entity 
that is disregarded as an entity separate from its owner. An eligible 
entity may also elect to change its classification, except that an 
election may not be made more than once in any sixty month period. An 
eligible entity that does not make an election is classified under 
certain default provisions.

Explanation of Provisions

Characterization of Elective Changes in Classification

    The proposed regulations describe how elective changes in an 
entity's classification will be treated for federal tax purposes. Under 
the final regulations, there are four possible changes in 
classification by election: (i) a partnership elects to be an 
association; (ii) an association elects to be a partnership; (iii) an 
association elects to be a disregarded entity; and (iv) a disregarded 
entity elects to be an association. There are two other possible ways 
in which an entity's classification could change (a partnership 
converts to a disregarded entity or a disregarded entity converts to a 
partnership) but these changes occur only as a result of a change in 
the number of members, not as the result of an elective change.
    The proposed regulations do not address the form of these two 
possible types of changes.
    The proposed regulations provide a specific characterization for 
each of the four possible elective changes. In each case, the 
characterization provided in the proposed regulations attempts to 
minimize the tax consequences of the change in classification and 
achieve administrative simplicity. The proposed regulations provide 
that if an association elects to be classified as a partnership, the 
association is deemed to liquidate by distributing its assets and 
liabilities to its shareholders. Then, the shareholders are deemed to 
contribute all of the distributed assets and liabilities to the 
partnership. This characterization of an elective change from an 
association to a partnership is consistent with Rev. Rul. 63-107 (1963-
1 C.B. 71).
    If a partnership elects to be classified as an association, the 
partnership is deemed to contribute all of its assets and liabilities 
to the association in exchange for stock in the association. Then, the 
partnership is deemed to liquidate by distributing stock in the 
association to its partners. The proposed regulations do not affect the 
holdings in Rev. Rul. 84-111 (1984-2 C.B. 88), in which the IRS ruled 
that it would respect the particular form undertaken by the taxpayers 
when a partnership converts to a corporation.
    If an association elects to be disregarded as an entity separate 
from its owner, the association is deemed to liquidate by distributing 
its assets and liabilities to its sole owner. Conversely, if an 
eligible entity that is disregarded as an entity separate from its 
owner elects to be classified as an association, the owner of the 
eligible entity is deemed to contribute all of the assets and 
liabilities of that entity to the association in exchange for stock of 
the association.
    The proposed regulations also provide that the tax treatment of an 
elective change in classification is determined under all relevant 
provisions of the Internal Revenue Code and general principles of tax 
law, including the step transaction doctrine. This provision in the 
proposed regulations is intended to ensure that the tax consequences of 
an elective change will be identical to the consequences that would 
have occurred if the taxpayer had actually taken the steps described in 
the proposed regulations. The IRS and Treasury request comments on the 
application of general principles of tax law to the transactions that 
are deemed to occur on an elective change in classification.

Change in Number of Members of Entity

    The proposed regulations address the effect of a change in the 
number of members on the classification of an entity. Under the 
proposed regulations, if there is a change in the number of members of 
an association, the classification of the entity is not affected. If an 
eligible entity classified as a partnership subsequently has only one 
member (and is still treated as an entity under local law), the entity 
will be disregarded as an entity separate from its owner. If a single 
member entity that is disregarded as an entity separate from its owner 
subsequently has more than one member, the entity is classified as a 
partnership as of the date the entity has more than one member. The 
classifications provided in the proposed regulations can be changed by 
election, assuming that the entity is not subject to the sixty month 
limitation on elections.

Timing of Elective Changes in Classification

    The proposed regulations provide that an election to change the 
classification of an entity is treated as occurring at the start of the 
day for which the election is effective. Any transactions that are 
deemed to occur as a result of the change in classification are treated 
as occurring immediately before the close of the day before the 
effective date of the election. For example, if an election is made to 
convert from an association to a partnership effective on January 1, 
the entity is treated as a partnership on January 1, and the deemed 
transactions specified in the proposed regulations are treated as 
occurring immediately before the close of December 31. As a result, 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.

Treatment of Foreign Eligible Entities

    Any eligible entity, including a foreign eligible entity whose 
classification is not relevant for federal tax purposes, may elect to 
change its classification. The IRS and Treasury request comments on the 
appropriateness of allowing such a foreign eligible entity to make a 
classification election, and comments on what the federal tax 
consequences of such an election should be (e.g., with respect to the 
basis of property held by the entity).

Foreign Per Se Entities

    The final regulations provide a list of the names of certain 
foreign business entities that are treated as corporations for federal 
tax purposes. In most cases,

[[Page 55770]]

the name by which an entity will be known is provided by the statutory 
corporate law of the relevant jurisdiction. In certain cases, however, 
the corporate law does not provide a statutory name. In these 
jurisdictions, taxpayers and practitioners often fill the statutory 
void with a name derived from a number of the statutory characteristics 
of the entity. In an effort to make the list of foreign per se 
corporations more accessible, the final regulations use the commonly 
used non-statutory term in certain cases where the statute does not 
provide a defined name. To minimize any uncertainty, however, the 
provisions of Sec. 301.7701-2(b)(8) (iii) and (iv) were included in the 
final regulations to address this issue. In response to comments from 
taxpayers, these subsections of the final regulations are clarified to 
provide guidance on the terms used in the final regulations. 
Furthermore, the regulations clarify that the term Berhad used with 
regard to Malaysia does not include a Sendirian Berhad (the equivalent 
of a private limited company). The regulations also clarify that, in 
relation 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). The fact that 
capital may be varied does not make this a different type of entity 
from a Sociedad Anonima that does not choose to apply the variable 
capital provision. These clarifications are not intended to change the 
interpretation of the final regulations.
    The proposed regulations also clarify the treatment of the Finnish, 
Maltese, and Norwegian entities specified in the final regulations. 
Effective January 1, 1996, Maltese and Norwegian corporate law 
recognized a distinction between public and private companies, and the 
proposed regulations reflect this change. The proposed regulations also 
provide that the rules of the final regulations with regard to the 
Maltese and Norwegian entities may be applied (when these proposed 
regulations are finalized) as though the entities specified in the 
proposed regulations had been included in the final regulations issued 
on December 18, 1996. Thus, a Maltese or Norwegian entity that is no 
longer treated as a per se corporation under the regulations would be 
able to make an election within 75 days of the date these proposed 
regulations are finalized, and such election could be effective as of 
January 1, 1997. Finnish law, since September 1, 1997, has recognized a 
similar distinction between public and private companies. It is 
proposed that a Finnish entity that is no longer treated as a per se 
corporation under the regulations would be able to make an election 
within 75 days of the date these proposed regulations are finalized, 
and such election could be effective as of September 1, 1997.

Special Basis Adjustments Under Section 743

    Section 743 provides that the basis of partnership property is not 
adjusted as the result of a transfer of an interest in the partnership 
by sale or exchange unless the partnership has made an election under 
section 754. If a section 754 election is made, the transferee partner 
is treated as having a special basis adjustment with respect to 
partnership property. This adjustment constitutes an adjustment to the 
basis of partnership property with respect to the transferee partner 
only. Some uncertainty has remained as to the treatment of this special 
basis adjustment upon the contribution of the partnership property to a 
corporation in a section 351 exchange, and because the proposed 
regulations provide for a deemed contribution by the partnership to a 
corporation in an elective conversion to an association, the proposed 
regulations address this uncertainty.
    The proposed regulations provide that a corporate transferee's 
basis in property transferred by a partnership in a transfer described 
in section 351 includes any special basis adjustment under section 743. 
The special basis adjustment is also taken into account in determining 
the partner's basis in the stock received in the exchange. For example, 
assume a partnership owns Property X, which has a common basis of $100 
for the partnership and in which Partner A has a $5 special basis 
adjustment under section 743(b). Subsequently, the partnership validly 
elects to be classified as an association. The partnership is deemed to 
contribute 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. If the transfer of the assets to the association would be 
a transfer described in section 351, then under the proposed 
regulations, the association's basis in Property X includes Partner A's 
$5 special basis adjustment. Thus, the association has a $105 basis in 
Property X (Partner A's $5 special basis adjustment plus the 
partnership's $100 common basis). Partner A's basis in the 
association's stock will reflect the $5 special basis adjustment 
previously on Property X.
    The proposed regulations also provide, however, that the amount of 
gain, if any, recognized by the partnership on the transfer is 
determined without reference to any special basis adjustment. The 
partner with the special basis adjustment can then use the special 
basis adjustment to reduce its share of any gain recognized by the 
partnership. This approach of determining gain at the partnership level 
and allowing the partner to use the special basis adjustment as an 
offset is similar to the treatment of a sale of property with a special 
basis adjustment.

Proposed Effective Date

    Except as otherwise specified, these regulations are proposed to 
apply as of the date the final regulations are published in the Federal 
Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 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 on small entities a collection of information 
requirement, 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, 
this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (preferably a 
signed original and eight (8) copies) that are submitted timely to the 
IRS. All comments will be available for public inspection and copying.
    A public hearing has been scheduled for February 24, 1997, at 10 
a.m., in room 2615, Internal Revenue Building, 1111 Constitution Avenue 
NW., Washington, DC. Because of access restrictions, visitors will not 
be admitted beyond the Internal Revenue Building lobby more than 15 
minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.

[[Page 55771]]

    Persons that wish to present oral comments at the hearing must 
submit timely written comments and an outline of the topics to be 
discussed and the time to be devoted to each topic by (preferably a 
signed original and eight (8) copies) January 26, 1998.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Ann M. Veninga, 
Office of Chief Counsel (Passthroughs and Special Industries) 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

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as 
follows.

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.743-2 is added under the undesignated 
centerheading ``Transfer of Interests in a Partnership'' to read as 
follows:


Sec. 1.743-2  Transfer of property to a corporation.

    (a) Basis in transferred property. A corporations adjusted tax 
basis in property transferred to the corporation by a partnership in a 
transfer described in section 351 is determined with reference to any 
special basis adjustment to the property under section 743(b) (other 
than any special basis adjustment that reduces a partner's gain under 
paragraph (b) of this section).
    (b) Partnership gain. The amount of gain, if any, recognized by a 
partnership on a transfer of property by the partnership to a 
corporation in a transfer described in section 351 is determined 
without reference to any special basis adjustment to the transferred 
property under section 743(b). The amount of gain, if any, recognized 
by the partnership on the transfer that is allocated to a partner with 
a special basis adjustment in the transferred property is adjusted to 
reflect the partner's special basis adjustment in the transferred 
property.
    (c) Basis in stock. The partnership's adjusted tax basis in stock 
received from a corporation in a transfer described in section 351 is 
determined without reference to the special basis adjustment in 
property transferred to the corporation in the section 351 exchange. A 
partner with a special basis adjustment in property transferred to the 
corporation, however, has a special basis adjustment in the stock 
received by the partnership in the section 351 exchange in an amount 
equal to the partner's special basis adjustment in the transferred 
property, reduced by any special basis adjustment that reduced the 
partner's gain under paragraph (b) of this section.
    (d) Effective date. This section applies to transfers that occur on 
or after the date final regulations are published in the Federal 
Register.

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 3. The authority citation for part 301 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 4. 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:


Sec. 301.6109-1  Identifying numbers.

* * * * *
    (h) Special rules for certain entities under Sec. 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 Sec. 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 Sec. 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. This paragraph (h) applies to changes in 
classification that occur on or after the date on which these 
regulations are published as final regulations in the Federal Register.
    Par. 5. Section 301.7701-2 is amended as follows:
    1. Paragraph (b)(8)(i) is amended by revising the entries for 
Finland, Malta, and Norway.
    2. Paragraph (b)(8)(ii)(A) is redesignated as paragraph 
(b)(8)(ii)(A)(1) and the language ``and'' at the end of the paragraph 
is removed.
    3. Paragraph (b)(8)(ii)(B) is redesignated as paragraph 
(b)(8)(ii)(A)(2) and the period at the end of the paragraph is removed 
and the language ``; and '' is added in its place.
    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:


Sec. 301.7701-2  Business entities; definitions.

* * * * *
    (b) * * *
    (8) * * *
    (i) * * *

Finland, Julkinen Osakeyhtio/Publikt Aktiebolag
* * * * *
Malta, Public Limited Company
* * * * *
Norway, Allment Aksjeselskap
* * * * *
    (ii) Clarification of list of corporations in paragraph (b)(8)(i) 
of this section--(A) Exceptions in certain cases. * * *
* * * * *
    (3) With regard to Malaysia, a Sendirian Berhad.

[[Page 55772]]

    (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, Jamaica, and Trinidad and 
Tobago, 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 the date the final 
regulations are published in the Federal Register. Any Maltese or 
Norwegian entity that becomes an eligible entity as a result of 
paragraph (b)(8)(i) of this section in effect on the date final 
regulations are published in the Federal Register may elect (within 75 
days of the date final regulations are published in the Federal 
Register) 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 the date final 
regulations are published in the Federal Register may elect (within 75 
days of the date final regulations are published in the Federal 
Register) 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. 6. Section 301.7701-3 is amended as follows:
    1. A sentence is added at the end of paragraph (c)(1)(iv).
    2. Paragraph (c)(2)(iii) is added.
    3. A heading is added to paragraph (d)(1).
    4. Paragraph (f) is redesignated as paragraph (h) and newly 
designated paragraph (h)(1) is revised.
    5. Paragraphs (f) and (g) are added.
    The revision and additions read as follows:


Sec. 301.7701-3  Classification of certain business entities.

* * * * *
    (c) * * *
    (1) * * *
    (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 purposes of 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 the 
date final regulations are published in the Federal Register.
    (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 is disregarded as an entity separate from 
its owner as of the date the entity has only one member. A single 
member entity disregarded as an entity separate from its owner is 
classified as a partnership as of the date the entity has more than one 
member.
    (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. (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 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. 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, 1999, 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 a separate entity as of the 
date 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 the date the 
final regulations are published in the Federal Register.
    (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

[[Page 55773]]

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. 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. As a result, 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.
    (4) Effective date. This paragraph (g) applies to elections that 
are filed on or after the date the final regulations are published in 
the Federal Register.
    (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.
* * * * *
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
[FR Doc. 97-28165 Filed 10-27-97; 8:45 am]
BILLING CODE 4830-01-U