IRS concludes conversion of LLC not a debt modification


The IRS has issued a private letter ruling (PLR 202337007) holding that the conversion of a limited liability company (LLC) to a corporation under state law would not result in a modification of a debt under Treas. Reg. Sec. 1.1001-3.


In the PLR, the parent (Parent) of a consolidated group owned a corporation that was a member of the parent’s consolidated group (Subsidiary 1).  Subsidiary 1 owned an interest in a partnership (LLC 4), which in turn owned an interest in another partnership (LLC 3). The other partners in both partnerships were unrelated. LLC 3 directly wholly owned an LLC that was disregarded a disregarded entity (DRE) for federal income tax purposes (LLC 2), which in turn wholly another DRE (LLC 1).


LLC 1 had outstanding publicly traded senior secured notes (term loans), and unsecured notes owed to unrelated parties that were not related. All the debt was recourse to LLC 1. The senior secured notes were guaranteed by LLC 2 and secured by all of the assets owned by LLC 1 and the guarantors. Parent, Subsidiary 1, LLC 3, and LLC 4 were not obligors or guarantors and had not pledged any assets as collateral for the LLC 1 Debt.


The parent group proposed the following three-step transaction:

  • LLC 3 will redeem all of the partnership interest owned by the unrelated partner for cash and LLC 3 would become a DRE owned by LLC 4 as a result.
  • LLC 4 will redeem all of the partnership interest owned by the unrelated partner for cash and LLC 4 would become a DRE owned by Subsidiary 1.
  • LLC 1 will convert to a corporation (Subsidiary 2) under applicable state law and Subsidiary 2 will become a member of the parent consolidated group as a result.

Under applicable state law, Subsidiary 2 remains the same legal entity as LLC 1 notwithstanding that it was a new corporation for federal income tax purposes. None of the debt-holders’ rights against LLC would be altered by the proposed transaction and the debt-holders would continue to have exactly the same legal relationship with Subsidiary 2 as they had with LLC 1.


Generally, Treas. Reg. Sec. 1.1001-3 provides that a “significant modification” of a debt instrument results in a deemed new debt instrument that is exchanged for the unmodified debt instrument. Under the regulations, a “modification” is any alteration and includes adding or deleting a legal right or obligation of the issuer or holder of a debt instrument. The regulations further provide that the substitution of a new obligor, adding and subtracting of a co-obligor, or a change in the recourse nature of a debt, is a modification and that the substitution of a new obligor on a recourse debt instrument is a significant modification.


A pivotal issue in the PLR was whether Subsidiary 2 would be regarded as a new obligor on the debt for purposes of Treas. Reg. Sec. 1.1001-3 even though it was the same legal entity as LLC 1.


The IRS ruled that the proposed transaction would not result in a modification of debt under Treas. Reg. Sec. 1.1001-3. The IRS based its ruling on the facts and applicable state law, which provided that Subsidiary 2 was the same legal entity as LLC 1 and the debt holders would continue to have the same legal rights against Subsidiary 2 as they previously had with LLC 1.



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