Is converting a Texas corporation into a partnership a taxable event for franchise tax, and does electing to be taxed as a corporation federally make the partnership taxable in Texas?

Plain-English summary

This letter is a taxpayer's ruling request that the Comptroller signed and approved. A Texas S corporation planned to convert into a registered limited liability partnership (under Tex. Bus. Corp. Act art. 5.17 and Tex. Revised Partnership Act arts. 6132b-9.05 and 6132b-3.08) and to file a federal "check-the-box" election (IRS Form 8832) so the resulting partnership would be taxed as an association taxable as a corporation for federal income tax purposes. The conversion was a nontaxable transaction federally.

The taxpayer asked the Comptroller to confirm two rulings, and the Franchise Tax Administration Division approved them (signed "Approved by: Teresa Comer, Date: 12/23/98"):

1. The conversion is not a taxable event for Texas franchise tax. Provided the conversion of the corporation into the partnership does not give rise to income or gain taxable to the corporation or partnership for federal income tax purposes, it likewise does not give rise to income or gain taxable for Texas franchise tax purposes.
2. The resulting partnership is not subject to Texas franchise tax — even though it elects to be taxed as an association taxable as a corporation for federal income tax purposes. In other words, the federal check-the-box election does not make the partnership a franchise-tax payer; Texas looks to the entity's legal form.

Important currency note: This 1998 letter reflects the franchise tax before the 2008 overhaul. The premise that a partnership escapes the 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current margin-based franchise tax, partnerships are generally taxable entities, and STAR marks this document partially superseded on the taxation of partnerships.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 not subject" conclusion as historical.

What this means for you

Businesses restructuring corporations into partnerships/LLPs

At the time, converting to a partnership form could take the entity out of franchise tax, and a federal corporate election did not undo that. That is no longer true — a limited (or registered) partnership is now generally a taxable entity in Texas. If you are evaluating or unwinding a structure built on this 1998 confirmation, re-check it against the current margin tax.

Anyone relying on "check-the-box"

Texas did not let a federal entity-classification election drive its franchise-tax treatment; it looked to how the entity was legally organized. Don't assume a Form 8832 election changes your Texas result.

Accountants and tax professionals

Note the conditional structure of ruling #1: the Texas non-recognition tracked the federal non-recognition of the conversion. The linkage of Texas treatment to federal treatment of the conversion is a useful concept, but the entity-level partnership conclusion is pre-2008 — confirm under current law.

Common questions

Q: Was converting the corporation into a partnership a taxable event for Texas franchise tax?
A: No — the Comptroller approved the ruling that if the conversion is not taxable federally, it is likewise not taxable for Texas franchise tax.

Q: Did the federal check-the-box election make the partnership taxable in Texas?
A: No. The approved ruling said the partnership is not subject to Texas franchise tax even though it elected to be taxed as a corporation federally.

Q: Is this still current?
A: No. It predates the 2008 margin tax, under which partnerships are generally taxable entities. STAR marks it partially superseded on the taxation of partnerships.

Citations and references

Statutes and authorities:

• Tex. Bus. Corp. Act art. 5.17 (conversion of a corporation)
• Tex. Revised Partnership Act arts. 6132b-9.05, 6132b-3.08 (conversion; registered limited liability partnership)
• IRS Form 8832 / Treasury "check-the-box" entity-classification election (referenced)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9812056L

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.

December 15, 1998

VIA FACSIMILE - **

Ms. Teresa Comer
Franchise Tax Administration Division
Comptroller of Public Accounts
Post Office Box 13582, Capitol Station
Austin, Texas 78711-3528

Re: Texas Franchise Tax

Dear Ms. Comer:

I am writing to request confirmation of the Texas franchise tax treatment of
the corporation and partnership described below.

Corporation A (the "Corporation") is incorporated in the State of Texas.
Corporation A is doing business in and owns property in Texas. Corporation A
reports its taxable income as an S corporation for United States Federal income
tax purposes. On or before December 31, 1998, the following will take place:

1. Pursuant to the provisions of Article 5.17 of the Texas Business
   Corporation Act and Article 6132b-9.05 of the Texas Revised Partnership Act,
   the Corporation will be converted from a corporation to a general partnership
   (the "Partnership"). Pursuant to Article 6132b-3.08 of the Texas Revised
   Partnership Act, the Partnership will take the necessary steps to qualify and
   register as a registered limited liability partnership.

2. Pursuant to the provisions of the United States Federal income tax
   regulations, the Partnership will file an election on Form 8832 (Entity
   Classification Election) with the Internal Revenue Service such that the
   Partnership will from the time of the conversion be taxed as an association
   taxable as a corporation for United States Federal income tax purposes.

3. The conversion of the Corporation into the Partnership will constitute a
   nontaxable transaction for United States Federal income tax purposes.

4. The Partnership will from the time of its conversion report its taxable
   income as an S corporation for United States Federal income tax purposes.

Rulings Requested

Set forth below are the rulings requested. If the rulings requested correctly
state the Texas franchise tax treatment of the Corporation and the Partnership,
please so indicate by signing a copy of this letter in the space provided below
and returning it to me by telecopy at (214) 651-4330.

1. Provided that the conversion of the Corporation into the Partnership does
   not give rise to the recognition of income or gain taxable to the Corporation
   or the Partnership for United States Federal income tax purposes, the
   conversion of the Corporation into the Partnership will likewise not give rise
   to income or gain taxable to the Corporation or the Partnership for Texas
   franchise tax purposes.

2. The Partnership will not be subject to Texas franchise tax even though the
   Partnership elects to be taxed as an association taxable as a corporation for
   United States Federal income tax purposes.

Please call me if you have any questions or require additional information. If
the rulings you propose to issue are contrary to the rulings requested above,
we request the opportunity to discuss the rulings with you before they are
issued.

Thank you for your assistance in this matter.

Sincerely,

The rulings requested above correctly state the Texas franchise taxation of the
entities and transactions described in this letter.

Approved by: Teresa Comer
Date: 12/23/98