Was a partnership's ratable, liability-free liquidation taxable when a trust then contributed its distributed equipment to a 95%-owned LLC?

Plain-English summary

This opinion reconsidered the hypothetical partnership-and-LLC transaction in the December 21, 1995 opinion supporting Annotation 395.2194 after the requester changed three facts. The partners would assume no partnership liabilities; the corporation would receive approximately 33 percent of the assets and the gift trust approximately 67 percent under the partnership agreement; and the trust would contribute only the dissolved partnership's distributed assets to the new LLC while retaining its cash and other investments.

The liability change reversed the prior partnership-liquidation result. Because the distribution was ratable under the agreement and neither partner assumed liabilities or gave consideration beyond surrendering its partnership interest, tax did not apply to the complete liquidation.

The trust's contribution to the LLC also remained exempt as an occasional sale. Although the trust retained cash and investments, staff understood that it would retain no tangible personal property after contributing the distributed business assets. It therefore transferred at least 80% of the tangible personal property used in its selling activities and retained 95% ownership of the LLC.

Tax Counsel Warren L. Astleford again respected the separate steps rather than treating them as a direct partnership-to-LLC sale. He accepted the stated plan to obtain partnership rather than corporate tax treatment as a valid business purpose rather than a California sales-tax-avoidance device. No completed liquidation, LLC transfer, reported tax, assessment, or later outcome is supplied.

Incorporated background, three revised facts, two-tier analysis, and missing outcome

The opinion answers the law firm's March 22, 1996 letter to Assistant Chief Counsel Gary J. Jugum, which is not included. Astleford opened by saying Board staff did not issue rulings and that section 6596 relief required disclosure of the taxpayer's identity and all relevant facts. The unidentified client therefore received an opinion outside section 6596. No client identity, complete facts, transaction documents, reliance, tax payment, penalty, or relief claim appears.

The requester had first presented the transaction in an October 3, 1995 letter, also absent. The Board's seven-page December 21, 1995 response is the official source for the background and analyses expressly incorporated into this three-page follow-up. Both PDFs were independently fetched and verified for this audit; the later page preserves its own original text below and cites the earlier source rather than silently treating incorporated content as if repeated in the follow-up.

The June opinion incorporates background from pages 1–4, liquidation analysis from pages 4–6, and collective analysis from pages seven and eight of that prior letter. The published December PDF contains seven physical pages, labels its last page -7, presents the collective analysis and section 6596 warning there, and ends with Astleford's signature. It supplies no page 8. The available page 7 supports the collective conclusion summarized here, but no absent page-8 content is inferred.

In the incorporated background, a limited partnership with a California seller's permit leased equipment and also sold and repaired it at several sites. Its corporate general partner held the preferred interest; an irrevocable generation-skipping gift trust held the nonpreferred interest. A married couple owned 81.32 percent of the corporation as community property, and their child owned 18.68 percent and served as sole trustee of the trust. The live annotation rounds those corporate shares to 81 and 19 percent.

The corporation's preferred interest carried a 10-percent return and priority for arrears and capital repayment. Its initial capital account was $72,600, while the trust's was $11,900; both had increased, and the partnership owed preferred-return arrears. The corporation had 85.92 percent of voting rights and the trust 14.08 percent. The incorporated opinion supplies no partnership agreement, capital-account ledger, arrears amount, cash distribution, voting record, trust instrument, valuation, or partner tax record.

The original proposal distributed fair-market-value assets in complete liquidation. Both partners would receive cash, receivables, equipment, and other property subject to liabilities. The corporation would continue the equipment business at one site; the trust would contribute its share to a newly formed California LLC that operated the remaining sites. The couple would concurrently contribute cash equal to 5 percent of the trust-contributed asset value, leaving the trust with 95 percent and the couple with 5 percent of the LLC.

The requester said the LLC would protect the trust from personal liability and obtain partnership rather than corporate federal tax treatment, citing California Corporations Code section 17050 and Treasury Regulation section 301.7701-2. Those were requester premises. Neither opinion supplies or decides entity formation, limited-liability effectiveness, federal classification, double taxation, a tax election, or a federal ruling.

The June 1996 request changed exactly three stated facts. First, neither partner would assume partnership liabilities. Second, the corporation would receive approximately 33 percent and the trust 67 percent of partnership assets. Astleford expressly assumed this was wholly consistent with the liquidation provisions and that neither partner received anything beyond its agreement entitlement. Third, the trust would contribute only the distributed partnership assets—not its other cash and investments—to the LLC. All other prior facts and proposed steps were assumed unchanged; the source warns that an incorrect assumption could change the answer.

Astleford applied two tiers. Each individual transfer first had to be tested between its parties. The series then had to be tested collectively to decide whether tax law should disregard intervening steps and view only the before-and-after transfer. Citing Annotation 395.1840, he said a series undertaken solely to avoid or alter California sales-or-use-tax liabilities would be disregarded.

For the liquidation, the incorporated December opinion had applied tax because the partners assumed liabilities as consideration. Under the revised facts, neither partner assumed any liability, each received assets in the same ratio as its partnership interest, and the partnership received no consideration beyond the interests surrendered for cancellation. Subject to the incorporated analysis, the complete liquidation was nontaxable.

The incorporated analysis supplies the legal basis: sections 6051, 6006(a), 6201, 6401, 6367, and 6006.5; Regulation 1595(b)(2), (b)(4), and (c); Annotations 395.2400 and 395.1800–395.2560; and three assumed-liability cases. Legal research resolved all three source-printed reporters to the named cases: Beatrice Co. v. State Board of Equalization, 6 Cal.4th 767; Newco Leasing, Inc. v. State Board of Equalization, 143 Cal.App.3d 120; and Cal-Metal Corp. v. State Board of Equalization, 161 Cal.App.3d 759. The opinions themselves are not reproduced in either letter, and their distinct facts are not imported into this hypothetical.

For the trust-to-LLC transfer, the prior opinion had assumed the trust contributed all real and personal property. The revised request said it retained cash and other investments. Astleford understood this to mean it retained title to no tangible personal property after transferring the partnership assets. On that understanding, it transferred at least 80 percent of tangible property held or used in selling activities. Because the couple contributed only 5 percent of asset value, the trust retained 95 percent LLC ownership and cleared Regulation 1595(b)(2)'s separate 80-percent ownership threshold.

No trust asset schedule, title, cash or investment record, tangible-property inventory, seller's-permit activity allocation, asset value, 80-percent numerator or denominator, LLC agreement, couple's contribution, ownership ledger, transfer, or closing is included. The opinion does not decide what happens if the trust retained other tangible property, the 33/67 distribution departed from the agreement, liabilities remained, ownership changed, or another selling activity entered the denominator.

Collectively, the earlier opinion assumed legitimate reasons for dissolving the partnership and identified both partnership tax treatment and liability protection for the LLC. The revised opinion expressly repeats partnership tax treatment as the valid reason for the trust transfer. Astleford therefore did not collapse the steps into a direct taxable partnership-to-LLC sale. No partnership dissolution reason is restated in June beyond incorporation, and neither source supplies business-purpose resolutions, tax advice, transaction timing, independent evidence, or a completed result.

The live annotation draws most background from the incorporated December source and preserves the revised no-liability facts, approximately 33/67 distributions, one-site/two-site operations, retained cash and investments but no tangible property, legitimate business purposes, separate-step treatment, 80-percent tests, and June 21, 1996 date. It omits the two absent requests; section 6596 warning; exact 81.32/18.68 and 85.92/14.08 interests; preferred-return, capital-account, arrears and federal premises; assumption that the distribution followed the agreement; two-tier framework and cited authority; conditional understandings; absent records; and lack of any completed transaction or tax outcome.

What this means for you

Partnerships liquidating to their owners

A ratable distribution can be nontaxable when it follows the operative agreement, the partnership receives only canceled partner interests, and no owner assumes entity liabilities or supplies other consideration. Preserve the agreement, debt payoff, asset values, and distribution ledger.

Trusts or owners contributing assets to an LLC

The 80-percent test focused on all relevant selling-activity tangible property, not retained cash and investments. Prove what the trust held before and after, what entered the denominator, and at least 80-percent ownership continuity; the hypothetical retained 95 percent.

Accountants and tax professionals

Small factual changes reversed the earlier liquidation result. Document liabilities, cancellation consideration, distribution rights and ratios, retained tangible property, ownership, timing, entity classification premises, and the independent business purpose for each step and the whole series.

Common questions

Q: Why did the revised partnership liquidation escape tax?

A: The partners assumed no liabilities, gave no other consideration, and received assets ratably under the partnership agreement.

Q: How were the partnership assets divided?

A: About 33% went to the corporation and 67% to the gift trust.

Q: Did the trust have to transfer its cash and investments to the LLC?

A: No. Staff focused on tangible personal property and understood that the retained cash and investments included none. The source supplies no trust asset schedule proving that understanding.

Q: What ownership did the trust retain in the LLC?

A: 95%, after the married couple contributed cash equal to 5% of the LLC asset value.

Q: Did this letter provide section 6596 reliance protection?

A: No. The client was unidentified, and staff said all relevant facts and the taxpayer's identity were required.

Q: What facts came from the earlier opinion?

A: It cites pages 1–4 for the partnership, trust, family ownership, business, agreement, sites and proposed steps; pages 4–6 for liquidation law; and pages 7–8 for collective analysis. The official prior PDF has only seven pages, so no page-8 content is available.

Q: What exactly changed from December 1995?

A: Liabilities were removed from partner distributions, the asset split was clarified as approximately 33/67 under the partnership agreement, and the trust would contribute only partnership assets while keeping cash and investments.

Q: Did the voting percentages control the asset split?

A: No stated conclusion says so. The incorporated facts gave 85.92/14.08 voting rights, while the revision assumed a separate approximately 33/67 asset distribution required by the liquidation provisions.

Q: Why was the original liquidation taxable but the revised one was not?

A: The original partners took assets subject to liabilities, which were consideration. The revision removed all partner liability assumptions and left only ratable distributions for canceled interests.

Q: Was the trust's no-tangible-property fact proven?

A: No. Astleford said he understood the retained cash and investments to mean the trust owned no tangible personal property after transfer; no asset schedule is included.

Q: Were the steps automatically respected?

A: No. Staff respected them on the stated nontax business purpose. A series undertaken solely to avoid or alter California tax would be disregarded.

Q: Did either source show the transactions closed?

A: No. They contain proposed hypothetical facts and no executed transfer, tax return, audit, assessment, payment, claim, appeal, or outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006.5, 6367, and 6596 — June 21 opinion
• California Revenue and Taxation Code §§ 6006(a), 6051, 6201, and 6401 — incorporated December 21 analysis
• California Sales and Use Tax Regulation 1595(b)(2), (b)(4), and (c) — direct or incorporated analysis
• California Corporations Code § 17050 and Treasury Regulation § 301.7701-2 — requester's entity and federal-tax premises in the incorporated facts
• Business Taxes Law Guide Annotations 395.1840, 395.2400, and 395.1800–395.2560
• Beatrice Co. v. State Board of Equalization (1993) 6 Cal.4th 767, 783; Newco Leasing, Inc. v. State Board of Equalization (1983) 143 Cal.App.3d 120, 126; and Cal-Metal Corp. v. State Board of Equalization (1984) 161 Cal.App.3d 759, 766 — incorporated assumed-liability authorities; all reporters resolved to the source-named cases
• Page 8 of the December 21, 1995 opinion — cited by the follow-up for collective analysis but absent from the seven-page official PDF
• March 22, 1996 and October 3, 1995 requests; partnership and LLC agreements; trust; capital and voting records; arrears; liabilities; asset schedules and values; distributions; ownership; business-purpose evidence; entity and federal-tax records; transfers; returns; audit; assessment; payment; claim; appeal; and outcome — described or implicated but not included

Verbatim support

From the official June 21, 1996 Warren L. Astleford opinion:

This opinion does not come within section 6596 because you have not identified your client.

You now state that the assets distributed to the partners as a result of the complete liquidation of the partnership will not be subject to any liabilities and that the partners will not assume any liabilities of the partnership.

Under these facts and subject to the analysis contained in our December 21, 1995 letter, tax does not apply to the partnership’s complete liquidation of assets to its partners.

We understand this to mean that the gift trust will not retain title to, or otherwise own, any tangible personal property after the transfer of the assets it acquired from the partnership to the LLC.

We regard this transfer as one for a valid business purpose and not for the purpose of avoiding California sales or use tax.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2193
• Original supporting opinion: 395.2193 PDF
• Incorporated prior opinion: 395.2194 PDF

Original ruling text

395.2193

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

JOHAN KLEHS
First District, Hayward

LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
Telephone: (916) 324-2637
FAX: (916) 323-3387

DEAN ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
BRAD SHERMAN
Fourth District, Los Angeles

June 21, 1996

KATHLEEN CONNELL
Controller, Sacramento

E. L. Sorensen, Jr.
Executive Director

Mr. R--- G---M--M---, M--- & P--XXX West ---, Suite XXX
--- ---, California XXXXX-XXXX
Re:

Unidentified Taxpayer;
Occasional Sales

Dear Mr. M---:
This is in response to your March 22, 1996 letter to Assistant Chief Counsel Gary J. Jugum requesting a ruling on the application of tax to a proposed partnership distribution and transfer of assets to a limited liability company (“LLC”) by hypothetical taxpayers. I initially note that the Board staff does not issue rulings. Revenue and Taxation Code section 6596 sets forth the circumstances under which a taxpayer may be relieved of liability for taxes when reasonably relying on a written response to a written request for an opinion. In order to come within the provisions of section 6596, all relevant facts, including the identity of the taxpayer, must be disclosed. This opinion does not come within section 6596 because you have not identified your client. You should provide us with the identity of your client (as well as all relevant facts) in your initial letter to us if you wish an opinion letter coming within the provisions of section 6596. You previously requested an opinion on this transaction in your October 3, 1995 letter to us. We responded to this request in our letter to you dated December 21, 1995. We understand that the facts surrounding your present request only differ from your previous request in three ways. First, the assets distributed to the two partners as a result of the complete liquidation of the partnership will not be subject to any liabilities (i.e., the partners would not assume any liabilities of the partnership). Second, you clarify that the corporation will receive approximately 33 percent of the assets of the partnership and that the gift trust would receive approximately 67 percent.1 Third, you state that the gift trust will only contribute the assets it receives from the dissolved partnership to the LLC. We understand and assume that all other facts regarding your clients and the proposed transactions are the same as previously set forth in your October 3, 1995 letter to us. (If this assumption is incorrect, our opinion below would be 1

We assume that net result of this distribution is wholly consistent with, and pursuant to, the liquidation provisions of the partnership agreement. That is, we assume that the corporation’s receipt of 33 percent (and the gift trust’s receipt of 67 percent) of the partnership’s assets is the result of the partnership agreement and that these two partners are not receiving a distribution that they would not otherwise receive under the terms of that agreement.

Mr. R--- G--- M---

-2-

June 21, 1996
395.2193

different.) In that regard, we incorporate by reference those background facts and facts regarding the proposed transaction as set forth in pages one through four of our December 21, 1995 letter to you. You ask us to address the same questions previously posed to us in your October 3, 1995 letter as they apply to the revised transaction. As we noted in our December 21, 1995 letter to you, some tangible personal property is ultimately being transferred from the partnership to a LLC owned by the gift trust and Mr. and Mrs. Taxpayer by way of multiple transactions between the several parties. These types of transactions require a two-tier analysis. First, each step in the series of transactions must be analyzed for the purpose of ascertaining if there is a taxable transaction between two parties. Second, the transactions must be collectively analyzed for the purpose of determining whether, under the California Sales and Use Tax Law, the intervening steps of the transaction should be disregarded and the transactions should be analyzed only on a before and after basis, with all intervening steps of the transaction disregarded for sales and use tax purposes. (See, e.g., Business Taxes Law Guide Annot. 395.1840 (3/1/66; 7/28/86).) That is, the individual series of transactions between the parties will be disregarded if they are undertaken solely for the purpose of avoiding or altering the California sales or use tax liabilities of the parties. With that in mind, I will first discuss whether tax applies to each of the individual transactions between the parties. A. Individual Transactions “[1.] [W]ould ... the proposed complete liquidation of the Partnership ... qualify for the occasional sale exemption under Revenue and Taxation Code § 6367 and
§ 6006.5 ... [such that] no sales tax would be due as a result of the liquidation[?]” We previously concluded that tax applied to the partnership’s distribution of its assets pursuant to a complete liquidation since each of the partners would assume some of the partnership’s liabilities. In that regard, we incorporate by reference our analysis regarding the application of tax to the distribution of a partnership’s assets as set forth in pages four through six of our December 21, 1995 letter to you. You now state that the assets distributed to the partners as a result of the complete liquidation of the partnership will not be subject to any liabilities and that the partners will not assume any liabilities of the partnership. That is, neither partner will provide consideration to the partnership in exchange for the distribution of the partnership’s assets. You also state that the assets of the partnership will be distributed to the partners in the same ratio as each partner’s interest in the partnership. Under these facts and subject to the analysis contained in our December 21, 1995 letter, tax does not apply to the partnership’s complete liquidation of assets to its partners. “[2.] [W]ould the proposed transfer by the Gift Trust to the newly formed LLC ... qualify for the occasional sale exemption under Revenue and Taxation

Mr. R--- G--- M---

-3-

June 21, 1996
395.2193

Code § 6367 and § 6006.5 ... [such that] no sales tax would be due as a result of the transfer of assets to the LLC[?]” We previously assumed that the gift trust transferred 100 percent of its total property (real and personal) to the LLC. On that basis, we concluded that tax did not apply to that transfer. You now state that the gift trust will only transfer those assets received from the dissolved partnership to the LLC. In particular, you state that “the gift trust’s other assets, which consist of cash and other investments, will remain in the gift trust and will not be contributed to the LLC.” We understand this to mean that the gift trust will not retain title to, or otherwise own, any tangible personal property after the transfer of the assets it acquired from the partnership to the LLC. Under these facts, the gift trust’s transfer to the LLC is exempt from tax as an occasional sale since it is transferring at least 80 percent of the tangible personal property it held or used in the course of its selling activities to the LLC, and the gift trust will maintain at least 80 percent ownership of the LLC (i.e., Mr. and Mrs. Taxpayer will only contribute 5 percent of the value of the assets of the LLC such that the gift trust retains a 95 percent ownership) at the conclusion of the transfer. B. Collective Transaction We previously concluded that we would not disregard the series of transactions between the partnership, gift trust, and LLC for sales and use tax purposes and not view the series of transactions taken as a whole as a taxable sale of tangible personal property from the partnership to the LLC. In that regard, we incorporate by reference our analysis regarding the proposed “collective transaction” as set forth in pages seven and eight of our December 21, 1995 letter to you. Under the revised set of facts you provided, we continue to understand that the gift trust will transfer its assets to the LLC in order to be taxed as a partnership and not as a corporation. We regard this transfer as one for a valid business purpose and not for the purpose of avoiding California sales or use tax. We therefore will not disregard the series of transactions between the parties for sales and use tax purposes. If you have any further questions, please write again. Sincerely,

Warren L. Astleford
Tax Counsel
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cc: --- --- District Administrator - ---