How to Convert a Partnership to a Corporation

Two Separate Decisions: State Law and Federal Tax Treatment

Converting a partnership to a corporation involves two distinct questions that are easy to conflate. The first is a state law question: how does your state's business organizations statute let you change from a partnership to a corporation? The second is a federal tax question: how does the IRS treat the assets, liabilities, and ownership interests moving from the partnership to the new corporation? A transaction can be handled cleanly under state law and still have tax consequences the partners didn't expect, so plan for both separately.

State-Level Options: Statutory Conversion or Asset Contribution

Many states now allow a statutory conversion, a single filing that converts a partnership directly into a corporation under the state's business organizations code, without needing to separately form a new entity and transfer assets into it. Not every state offers this option for every entity combination, so check your specific state's statute. Where a statutory conversion isn't available, the traditional approach is to form a new corporation, then contribute the partnership's assets (or the partners' partnership interests) to it in exchange for stock, followed by winding down the partnership.

The Three IRS-Recognized Methods

For federal tax purposes, Revenue Ruling 84-111 describes three ways a partnership can become a corporation, and the IRS respects whichever one the partners actually carry out: the assets-over method (the partnership transfers its assets to the new corporation in exchange for stock, then liquidates by distributing that stock to the partners); the assets-up method (the partnership distributes its assets to the partners, who then individually contribute them to the corporation); and the interests-over method (the partners contribute their partnership interests to the corporation, which is treated as if it received the partnership's assets directly). Which method the partners actually follow matters, because each produces different results for the corporation's basis in the contributed assets and the partners' holding period in their new stock.

Keeping the Transaction Tax-Free Under Section 351

Regardless of which of the three methods is used, the transfer of property to the new corporation is generally tax-free under Internal Revenue Code Section 351 if the people contributing property are, immediately after the exchange, in control of the corporation, meaning they own stock representing at least 80% of its total voting power and at least 80% of its other share classes. Most straightforward partnership-to-corporation conversions, where the same partners become the corporation's shareholders in roughly the same proportions, satisfy this test without difficulty. A conversion that brings in significant new outside investors alongside the incorporation can complicate whether the 80% test is met, so check the ownership math before assuming the transaction is automatically tax-free.

The New Corporation Needs Its Own EIN

Per the IRS, a business must obtain a new EIN when it incorporates. The partnership's existing EIN doesn't carry over to the new corporation, even if the ownership and operations are otherwise unchanged; apply for the corporation's EIN as part of the conversion, not as an afterthought once you're ready to open a bank account.

Steps After the Conversion

Once the conversion is complete, the new corporation needs its own articles of incorporation on file, its own bylaws, its own stock issued and recorded in a stock ledger, and its own registered agent. File the partnership's final tax return reflecting the transfer, and make sure contracts, licenses, and bank accounts that were in the partnership's name are reissued or assigned to the new corporation, since they generally don't transfer automatically just because the business is the same.

Not Every State Offers a Statutory Conversion for Every Entity Type

Before planning around a simple one-filing statutory conversion, confirm your specific state's business organizations statute actually allows converting your type of partnership directly into a corporation. Where it doesn't, you'll need the longer path of forming a new corporation and contributing assets or interests to it.

The Method You Choose Affects Basis and Holding Period, Not Just Paperwork

The assets-over, assets-up, and interests-over methods aren't interchangeable from a tax standpoint; they can produce different results for the corporation's basis in contributed assets and the partners' holding period in their new stock. Decide which method to use deliberately, with professional input, rather than letting the paperwork default to whichever is most convenient.

Contracts, Licenses, and Leases Don't Transfer Automatically

A lease, vendor contract, loan, or professional license issued to the partnership generally doesn't carry over to the new corporation without the other party's consent or a separate assignment. Review every material agreement the partnership holds and address each one specifically as part of the conversion.

This Is Not Legal or Tax Advice

Which state-law conversion method is available, and whether your specific transaction qualifies for tax-free treatment under Section 351, depends on your state and your ownership structure. Talk to a business attorney and a tax professional before converting a partnership to a corporation.