When a corporation or LLC converts into a Texas limited partnership and the partnership sells its assets, who owes franchise tax, and what final filings are required?

Plain-English summary

A taxpayer planned to convert a corporation (or LLC) into a Texas limited partnership effective November 1, 1998, after which the partnership would sell substantially all of its assets (a roughly $1 million gain) and elect to be treated as an association taxable as a corporation for federal income tax purposes. The taxpayer asked the Comptroller seven questions about the franchise tax consequences.

The Comptroller's answers:

1. Final report, not a full new return. If the corporation already filed its 1998 regular annual report, it only needs to file a final report for the short period (here, January 1 – October 31, 1998), and it must obtain a certificate of account status (Form 05-329), requested on the back of the final return.
2. The $1 million gain is not taxed. Because the limited partnership is not subject to franchise tax, it owes no franchise tax on the gain from the asset sale.
3. Federal corporate treatment doesn't matter. The partnership is not subject to franchise tax even if it is taxed like a corporation federally.
4. Tax numbers/permits carry over. For franchise tax the partnership needs no taxpayer number, and existing permits for other taxes the agency administers transfer to the partnership without new applications.
5. No proration; no refund. Once the conversion is effective (start of day November 1, 1998), the corporation no longer exists and is not subject to franchise tax from that date. It files a final report and pays any additional tax; it owes nothing more for the rest of the year and gets no refund for the remainder of the privilege period.
6. A corporate/LLC general partner still pays. Individual shareholders becoming limited partners are not subject to franchise tax, but a corporation or LLC that is the general partner is — even at 1% ownership. It reports surplus and receipts under Rules 3.549(e)(29) and 3.551(d)(1)(B), includes partnership income in earned surplus to the extent in federal taxable income, and includes its share of partnership gross receipts, apportioned as if directly earned.
7. Same answers for C corp, S corp, or LLC. The entity type of the converting corporation does not change the analysis.

Important currency note: This 1998 letter reflects the franchise tax before the 2008 overhaul. The central premise — that the converted partnership escapes franchise tax — is exactly what changed; under the current margin-based franchise tax, partnerships are generally taxable entities, and STAR marks this document partially superseded on the taxation of partnerships. Treat the "partnership and its gain are untaxed" outcome as historical.

What this means for you

Businesses converting and then selling assets

The 1998 planning idea — convert to a partnership so a big asset-sale gain lands in a non-taxable entity — no longer works the way this letter describes, because limited partnerships are now generally taxable. What does endure: on any conversion you must file a final report, get a certificate of account status, and expect no proration or refund for the unused part of the year.

General partners

Watch the general-partner exposure: a corporate or LLC general partner remains a franchise-tax payer and picks up its share of the partnership's income and receipts — even at a 1% stake. Individual partners are not franchise-tax payers.

Accountants and tax professionals

The short-period final-report mechanics and the certificate-of-account-status step are still practical checkpoints on a conversion, but the entity-level partnership conclusions are pre-2008. Re-verify under the current margin tax, and note the Rules 3.549(e)(29)/3.551(d)(1)(B) reporting for a corporate partner may differ under current law.

Common questions

Q: When a corporation converts to a limited partnership, what does it file?
A: A final franchise tax report for the short period through the conversion date, plus a request for a certificate of account status (Form 05-329). There is no proration or refund for the rest of the year.

Q: Was the partnership's $1 million asset-sale gain taxed?
A: No — the partnership was not subject to franchise tax, so it owed nothing on the gain. (That entity-level result is pre-2008.)

Q: Does a corporate general partner still owe franchise tax?
A: Yes. A corporation or LLC that is the general partner remains subject and includes its share of the partnership's income and receipts (Rules 3.549(e)(29), 3.551(d)(1)(B)); individual partners do not.

Q: Does the converting entity's type (C corp, S corp, LLC) change the result?
A: No. The Comptroller said the answers are the same for each.

Citations and references

Rules and forms:

• Franchise Tax Rule 3.549(e)(29) (corporate partner — reporting surplus/gross method)
• Franchise Tax Rule 3.551(d)(1)(B) (corporate partner — reporting receipts)
• Comptroller Form 05-329 (Certificate of Account Status)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9811160L

Original ruling text

STAR SUPERSED INFORMATION
Accession No. —
Supersede type - Partial
Document superseded on - 12/10/14
Issue(s) that caused the document to be superseded — Taxation of partnerships
Reason(s): The Franchise Tax Code was amended by House Bill 3 and House Bill 3928,
Acts 2007, 80th Legislative Session, effective January 1, 2008 and affected Franchise
tax reports due on or after January 1, 2008. One of the many changes to this Tax Code
subjected partnerships (previously not required to file) to the franchise tax reporting
requirement.

November 18, 1998

Dear Mr. **:

In your letter of October 30, you requested a determination regarding the
franchise tax consequences of converting a corporation or limited liability
company (LLC) into a Texas limited partnership.

You indicate that the corporation (which may be a foreign or domestic
corporation) elects to convert to a Texas limited partnership effective
November 1, 1998. The corporation had profits through this date. The limited
partnership sells substantially all of its assets on November 15, 1998
generating a gain of approximately $1 million. Under the partnership
agreement, the partnership elects to be treated as an association taxable as a
corporation for federal income tax purposes.

I have restated your questions below followed by a response.

1. Upon converting the corporation to a limited partnership would a franchise
   tax report be filed for the corporation prior or commensurate with the filing
   of the plan of exchange and the articles of conversion? Would that be shown as
   a final tax return for the corporation for the time period of January 1, 1998
   through October 31, 1998? Is it necessary to secure a certificate of account
   status for the conversion similar to when you file dissolution papers for a
   corporation?

Response

If the corporation previously filed the 1998 regular annual report, the
corporation only needs to file a final report. If the conversion was effective
at the beginning of the day on November 1, 1998 and the ending date for earned
surplus was December 31, 1997 on the 1998 regular annual report, the net
taxable earned surplus on final report would be based on the period from
January 1, 1998 through October 31, 1998.

The corporation will need to obtain a certificate of account status (Form No.
05-329). You can request the certificate by completing the form on the back of
the final return.

2. Would there by any franchise tax on the hypothetical $1 million gain from
   the sale of substantially all of the assets of the Texas limited partnership
   from the sale occurring November 15, 1998?

Response

The limited partnership is not subject to franchise tax. Therefore, the
partnership would owe no franchise tax related to the gain.

3. Would the fact that the Texas limited partnership is electing to be taxed
   effectively like a corporation at the federal level have any impact on state
   franchise tax?

Response

The limited partnership is not subject to franchise tax even if it is taxed
like a corporation for federal income tax purposes.

4. Since the Texas limited partnership would retain the same federal
   identification number as the original corporation, would all of the tax numbers
   for the limited partnership be the same as the previous corporation for state
   purposes, including state sales tax permits? Would any new sales tax permits
   or other types of filings need to be made for the limited partnership following
   the conversion of the corporation?

Response

For franchise tax purposes, the partnership would not need a taxpayer number.
The partnership would not need to apply for new permits for other taxes
administered by this agency as any existing permits will be transferred.

5. When the conversion is effectuated, is that the date that we become totally
   exempt from franchise tax? For example, is there any proration of franchise
   tax if we convert on November 1, 1998?

Response

If the conversion was effective at the beginning of the day on November 1,
1998, the corporation would no longer exist and, thus, would not be subject to
franchise tax as of that date. The corporation would need to file a final
report and pay any additional tax due on that report. The corporation would
not owe any other franchise tax for the period from January 1, 1998 through
October 1, 1998 and would not be entitled to any refund for the remainder of
the 1998 calendar year privilege period (i.e., November 1, 1998 through
December 31, 1998).

6. The limited partnership would have a corporation or a limited liability
   company as general partner owning 1% with the shareholders of the original
   corporation becoming limited partners in the limited partnership. Under those
   circumstances, would the sale by the limited partnership be 99% exempt from the
   payment of any franchise tax since the general partner who pays franchise tax
   only owns 1% of the Texas limited partnership?

Response

If the shareholders of the corporation are individuals, they obviously would
not be subject to franchise tax. If a corporation or LLC is a general partner
in the limited partnership, the corporation/LLC would be subject to franchise
tax.

In computing taxable capital, the corporation/LLC would report surplus and
receipts as indicated in Rule 3.549(e)(29) and Rule 3.551(d)(1)(B)
respectively. I have enclosed copies of these rule provisions.

The corporation/LLC would include partnership income in taxable earned surplus
to the extent included in federal taxable income. The corporation/LLC would
include its share of the partnership gross receipts included in federal taxable
income in calculating gross receipts. The receipts are apportioned as though
directly earned by the corporation/LLC.

7. Would your answers differ if the entity converting was a C corporation, S
   corporation, and/or a limited liability company or would the answers be the
   same for each?

Response

The answers are the same.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have any questions, contact Tax Policy Division. You may call toll free
1-800-531-5441, or our regular number is 512/463-4600. My extension is 3-4662.
You may write me at Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Bob Jeffcoat
Tax Policy Division