[Federal Register Volume 64, Number 228 (Monday, November 29, 1999)]
[Rules and Regulations]
[Pages 66580-66585]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-30504]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 8844]
RIN 1545-AV16


Treatment of Changes in Elective Entity Classification

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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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 
Sec. 301.7701-2(e) and Sec. 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 
Secs. 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 Secs. 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 Sec. 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

[[Page 66581]]

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 Sec. 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 
Sec. 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 Sec. 301.7701-3(g)(1) will occur immediately after 
the completion of the section 338 transactions. These rules follow the 
approach of Sec. 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 Sec. 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 
Sec. 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

[[Page 66582]]

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 Sec. 301.6109-1(h) are applicable as of January 1, 1997. 
Certain changes to Sec. 301.7701-2(b)(8) may be applied before the 
effective date as specified in Sec. 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:

[[Page 66583]]

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:


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. 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 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:


Sec. 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:


Sec. 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

[[Page 66584]]

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

[[Page 66585]]

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.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: November 2, 1999.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 99-30504 Filed 11-26-99; 8:45 am]
BILLING CODE 4830-01-U