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Adverse Tax Consequences Under the New Connecticut Entity Transaction Act

Posted by Morris Banks
September 17, 2014 

The Connecticut Entity Transaction Act (“CETA”) was enacted by the Connecticut General Assembly in 2011 and became effective on January 1, 2014.  It is intended to make Connecticut competitive with other states that grant corporations, limited liability companies, limited partnerships, and limited liability partnerships the statutory authority to merge or combine in cross species or cross entity transactions.  Previous to the enactment of CETA, Connecticut had no authority permitting such transactions.  For instance, the new act now authorizes conversions of one type of entity into another; the domestication of a foreign entity, that is to say permitting such entity to become a Connecticut entity under Connecticut Law; and the merger of a limited liability company into a corporation or a corporation into a limited liability company.

However, notwithstanding such salutary authority under Connecticut law, certain of these transactions may result in unintended adverse tax consequences.  In general, domestications of entities of the same type, the conversion of a general partnership or limited partnership into an LLC, the merger of a general partnership or limited partnership into an LLC or the merger of a general partnership or limited partnership or LLC into a corporation can all be effected without any adverse tax consequences, (or recognition of gain).  However, such is not the case with a merger of a corporation into an LLC or partnership or the conversion of a corporation into an LLC or partnership.  Such latter transactions can result in potentially devastating tax consequences on two levels.  First, such a merger or conversion of a corporation into a partnership can result in the recognition of taxable gain at the corporate level as if the corporation had been liquidated into the partnership.  Second, the equity owners of the surviving entity are deemed to have received a liquidating distribution that will likely result in recognition of a taxable gain. 

In other words, parties attempting to take advantage of certain aspects of the newly created Connecticut statutory authority on cross species mergers or conversions could be subjected to two potentially substantive taxes on such merger or conversion. 

Accordingly, it is important for the business person who wants to take advantage of this Connecticut statutory authority to seek counseling in order to avoid, if at all possible, these adverse tax consequences.

 

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