Tax Consequences of Merging Two LLCs
An LLC merger's tax impact is defined not by its legal structure, but by each entity's underlying tax classification. Learn how the IRS views these transactions.
When two Limited Liability Companies (LLCs) combine in a merger, one entity absorbs the other, transferring all its assets, debts, and obligations to the surviving LLC. While state law governs the legal mechanics, the Internal Revenue Service (IRS) determines the tax consequences. The IRS has no specific rules for “LLC mergers,” instead analyzing the transaction based on the federal tax classification of each company. This underlying classification is the primary factor that dictates which set of tax rules applies. The consequences can range from a completely tax-free event to a transaction where gains and losses must be recognized immediately.
Foundational LLC Tax Classifications
An LLC has flexibility in how it is taxed by the federal government, a choice that is foundational to merger consequences. The default classification depends on the number of members. A single-member LLC is a “disregarded entity,” meaning its financial activities are reported on the owner’s personal tax return as if the LLC does not exist separately.
For an LLC with two or more members, the default classification is a partnership. The LLC itself does not pay income tax but files an informational Form 1065, and profits or losses are “passed through” to the members to report on their own returns.
Beyond these defaults, an LLC can elect to be taxed as a corporation. By filing Form 8832, it can be treated as a C corporation, which pays tax at the entity level. Alternatively, an eligible LLC can file Form 2553 to elect S corporation status, which combines pass-through taxation with a corporate legal structure.
Tax Treatment of Partnership Mergers
When two LLCs taxed as partnerships merge, the IRS provides two methods for structuring the transaction: the “Assets-Over” form and the “Assets-Up” form. The chosen form can lead to different tax outcomes regarding the basis of assets in the new entity.
The Assets-Over form is the default treatment. In this scenario, the terminating partnership is deemed to transfer all its assets and liabilities to the surviving partnership for an ownership interest. Immediately after, the terminating partnership is considered to have distributed these new ownership interests to its partners, completing its liquidation. This transaction is tax-free, and the tax basis of the assets carries over to the surviving partnership.
Alternatively, the parties can structure the merger using the Assets-Up form. Under this method, the terminating partnership is deemed to first distribute all its assets and liabilities to its partners in a liquidation. The partners are then deemed to contribute those same assets to the surviving partnership for ownership interests. While also tax-free, this form can result in a different tax basis for the contributed assets, which affects future depreciation deductions and the calculation of gain or loss on a future sale of those assets.
Mergers Involving Disregarded Entities
When a merger involves a single-member LLC treated as a disregarded entity, the IRS views the transaction as one involving the single owner directly. The tax consequences depend on which entity is the acquirer and which is the target.
If a disregarded entity merges into an LLC taxed as a partnership, the IRS treats it as a contribution of the disregarded entity’s assets by its owner to the partnership. In exchange, the owner receives a partnership interest. This contribution is tax-free, but the owner must recognize a gain if the liabilities transferred exceed the tax basis of the contributed assets.
Conversely, if a partnership merges into a disregarded entity, the transaction is treated as if the partnership sold all its assets to the single owner. The partnership would recognize any gain or loss on this sale, which would then pass through to its partners. The partnership is then treated as having distributed the proceeds to its partners in a complete liquidation.
When two disregarded entities merge, the transaction is viewed as one owner selling assets to the other. If the surviving LLC has two owners after the merger, it can no longer be a disregarded entity and is converted into a partnership for tax purposes.
Mergers Involving Corporate-Taxed LLCs
When an LLC taxed as a C or S corporation merges, the transaction falls under the corporate reorganization provisions of the Internal Revenue Code. The goal of these rules is to allow the transaction to occur on a tax-deferred basis, known as a “tax-free reorganization.”
For a merger to qualify as a tax-free reorganization, it must meet several requirements. One is the “business purpose” doctrine, which mandates that the merger is for a genuine business reason and not solely for tax avoidance. Another is “continuity of interest,” which requires that the shareholders of the target corporation maintain a significant continuing equity interest in the acquiring corporation.
If the merger qualifies, the corporations involved do not recognize gain or loss on the transfer of assets. Shareholders of the target corporation who exchange their stock for stock in the acquiring corporation also do not recognize immediate gain or loss. The tax is deferred until they sell the new stock, and the basis of the assets and stock is carried over to the new entity.
Post-Merger Administrative Tax Steps
After an LLC merger is complete, several administrative actions are necessary for tax compliance. The terminating entity has a final tax filing obligation. For an LLC taxed as a partnership, a final Form 1065 must be filed for the short tax year ending on the merger date, with the “final return” box checked. An LLC taxed as an S corporation would file a final Form 1120-S.
The need for a new Employer Identification Number (EIN) depends on the merger’s structure. If the surviving entity is the same one that existed before the merger, it will keep its existing EIN. However, a new EIN is required when a new entity is formed, such as when two disregarded entities merge into a new multi-member LLC classified as a partnership.
In situations treated as an asset acquisition for tax purposes, additional reporting is required. The buyer and seller must agree on an allocation of the purchase price among the transferred assets. This allocation is then reported to the IRS by both parties on Form 8594, Asset Acquisition Statement, which is filed with their respective tax returns.