Internal Revenue Bulletin: 2010-45
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November 8, 2010
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Notice of Proposed Rulemaking Series LLCs and
Cell Companies
AGENCY:
Internal Revenue
Service (IRS), Treasury.
Notice of
proposed rulemaking.
This document
contains proposed regulations regarding the classification for Federal tax
purposes of a series of a domestic series limited liability company (LLC), a
cell of a domestic cell company, or a foreign series or cell that conducts an
insurance business. The proposed regulations provide that, whether or not a
series of a domestic series LLC, a cell of a domestic cell company, or a
foreign series or cell that conducts an insurance business is a juridical
person for local law purposes, for Federal tax purposes it is treated as an
entity formed under local law. Classification of a series or cell that is
treated as a separate entity for Federal tax purposes generally is determined
under the same rules that govern the classification of other types of separate
entities. The proposed regulations provide examples illustrating the
application of the rule. The proposed regulations will affect domestic series
LLCs; domestic cell companies; foreign series, or cells that conduct insurance
businesses; and their owners.
Written or
electronic comments and requests for a public hearing must be received by
December 13, 2010.
Send submissions
to: CC:PA:LPD:PR (REG-119921-09), Room 5203, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washington, DC 20044. Submissions may be
hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to
CC:PA:LPD:PR (REG-119921-09), Courier’s Desk, Internal Revenue Service, 1111
Constitution Avenue, NW, Washington, DC, or sent electronically, via the
Federal eRulemaking portal at www.regulations.gov (IRS REG-119921-09)
FOR FURTHER INFORMATION CONTACT:
Concerning the
proposed regulations, Joy Spies, (202) 622-3050; concerning submissions of
comments, Oluwafunmilayo (Funmi) Taylor, (202) 622-7180 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
A number of
states have enacted statutes providing for the creation of entities that may
establish series, including limited liability companies (series LLCs). In general,
series LLC statutes provide that a limited liability company may establish
separate series. Although series of a series LLC generally are not treated as
separate entities for state law purposes and, thus, cannot have members, each
series has “associated” with it specified members, assets, rights, obligations,
and investment objectives or business purposes. Members’ association with one
or more particular series is comparable to direct ownership by the members in
such series, in that their rights, duties, and powers with respect to the
series are direct and specifically identified. If the conditions enumerated in
the relevant statute are satisfied, the debts, liabilities, and obligations of
one series generally are enforceable only against the assets of that series and
not against assets of other series or of the series LLC.
Certain
jurisdictions have enacted statutes providing for entities similar to the
series LLC. For example, certain statutes provide for the chartering of a legal
entity (or the establishment of cells) under a structure commonly known as a
protected cell company, segregated account company or segregated portfolio
company (cell company). A cell company may establish multiple accounts, or
cells, each of which has its own name and is identified with a specific
participant, but generally is not treated under local law as a legal entity
distinct from the cell company. The assets of each cell are statutorily
protected from the creditors of any other cell and from the creditors of the
cell company.
Under current
law, there is little specific guidance regarding whether for Federal taxpurposes a series (or cell) is treated as an entity separate from other series
or the series LLC (or other cells or the cell company, as the case may be), or
whether the company and all of its series (or cells) should be treated as a
single entity.
Notice 2008-19,
2008-1 C.B. 366 requested comments on proposed guidance concerning issues that
arise if arrangements entered into by a cell constitute insurance for Federal
income tax purposes. The notice also requested comments on the need for
guidance concerning similar segregated arrangements that do not involve
insurance. The IRS received a number of comments requesting guidance for
similar arrangements not involving insurance, including series LLCs and cell
companies. These comments generally recommended that series and cells should be
treated as separate entities for Federal tax purposes if they are established
under a statute with provisions similar to the series LLC statutes currently in
effect in several states. The IRS and Treasury Department generally agree with
these comments. See §601.601(d)(2)(ii)(b).
2. Entity Classification for Federal Tax Purposes
Sections
301.7701-1 through 301.7701-4 of the Procedure and Administration Regulations
provide the framework for determining an organization’s entity classification
for Federal tax purposes. Classification of an organization depends on whether
the organization is treated as: (i) a separate entity under §301.7701-1, (ii) a
“business entity” within the meaning of §301.7701-2(a) or a trust under
§301.7701-4, and (iii) an “eligible entity” under §301.7701-3.
Section
301.7701-1(a)(1) provides that the determination of whether an entity is separate
from its owners for Federal tax purposes is a matter of Federal tax law and
does not depend on whether the organization is recognized as an entity under
local law. Section 301.7701-1(a)(2) provides that a joint venture or other
contractual arrangement may create a separate entity for Federal tax purposes
if the participants carry on a trade, business, financial operation, or venture
and divide the profits therefrom. However, a joint undertaking merely to share
expenses does not create a separate entity for Federal tax purposes, nor does
mere co-ownership of property where activities are limited to keeping property
maintained, in repair, and rented or leased. Id.
Section
301.7701-1(b) provides that the tax classification of an organization
recognized as a separate entity for tax purposes generally is determined under
§§301.7701-2, 301.7701-3, and 301.7701-4. Thus, for example, an organization
recognized as an entity that does not have associates or an objective to carry
on a business may be classified as a trust under §301.7701-4.
Section
301.7701-2(a) provides that a business entity is any entity recognized for
Federal tax purposes (including an entity with a single owner that may be
disregarded as an entity separate from its owner under §301.7701-3) that is not
properly classified as a trust or otherwise subject to special treatment under
the Internal Revenue Code (Code). A business entity with two or more members is
classified for Federal tax purposes as a corporation or a partnership. See
§301.7701-2(a). A business entity with one owner is classified as a corporation
or is disregarded. See §301.7701-2(a). If the entity is disregarded, its
activities are treated in the same manner as a sole proprietorship, branch, or
division of the owner. However, §301.7701-2(c)(2)(iv) and (v) provides for an
otherwise disregarded entity to be treated as a corporation for certain Federal
employment tax and excise tax purposes.
Section
301.7701-3(a) generally provides that an eligible entity, which is a business
entity that is not a corporation under §301.7701-2(b), may elect its
classification for Federal tax purposes.
B. Separate entity classification
The threshold
question for determining the tax classification of a series of a series LLC or
a cell of a cell company is whether an individual series or cell should be
considered an entity for Federal tax purposes. The determination of whether an
organization is an entity separate from its owners for Federal tax purposes is
a matter of Federal tax law and does not depend on whether the organization is
recognized as an entity under local law. Section 301.7701-1(a)(1). In Moline
Properties, Inc. v. Commissioner, 319 U.S. 436 (1943), the Supreme Court
noted that, so long as a corporation was formed for a purpose that is the equivalent
of business activity or the corporation actually carries on a business, the
corporation remains a taxable entity separate from its shareholders. Although
entities that are recognized under local law generally are also recognized for
Federal tax purposes, a state law entity may be disregarded if it lacks
business purpose or any business activity other than tax avoidance. See Bertoli
v. Commissioner, 103 T.C. 501 (1994); Aldon Homes, Inc. v. Commissioner,
33 T.C. 582 (1959).
The Supreme Court
in Commissioner v. Culbertson, 337 U.S. 733 (1949), and Commissioner
v. Tower, 327 U.S. 280 (1946), set forth the basic standard for determining
whether a partnership will be respected for Federal tax purposes. In general, a
partnership will be respected if, considering all the facts, the parties in
good faith and acting with a business purpose intended to join together to
conduct an enterprise and share in its profits and losses. This determination
is made considering not only the stated intent of the parties, but also the
terms of their agreement and their conduct. Madison Gas & Elec. Co. v.
Commissioner, 633 F.2d 512, 514 (7th Cir. 1980); Luna v.
Commissioner, 42 T.C. 1067, 1077-78 (1964).
Conversely, under
certain circumstances, arrangements that are not recognized as entities under
state law may be treated as separate entities for Federal tax purposes. Section
301.7701-1(a)(2). For example, courts have found entities for tax purposes in
some co-ownership situations where the co-owners agree to restrict their
ability to sell, lease or encumber their interests, waive their rights to
partition property, or allow certain management decisions to be made other than
by unanimous agreement among co-owners. Bergford v. Commissioner, 12
F.3d 166 (9th Cir. 1993); Bussing v. Commissioner, 89 T.C.
1050 (1987); Alhouse v. Commissioner, T.C. Memo. 1991-652. However, the
Internal Revenue Service (IRS) has ruled that a co-ownership does not rise to
the level of an entity for Federal tax purposes if the owner employs an agent
whose activities are limited to collecting rents, paying property taxes,
insurance premiums, repair and maintenance expenses, and providing tenants with
customary services. Rev. Rul. 75-374, 1975-2 C.B. 261. See also Rev. Rul.
79-77, 1979-1 C.B. 448, (see §601.601(d)(2)(ii)(b).
Rev. Proc.
2002-22, 2002-1 C.B. 733, (see §601.601(d)(2)(ii)(b)), specifies the
conditions under which the IRS will consider a request for a private letter
ruling that an undivided fractional interest in rental real property is not an
interest in a business entity under §301.7701-2(a). A number of factors must be
present to obtain a ruling under the revenue procedure, including a limit on
the number of co-owners, a requirement that the co-owners not treat the
co-ownership as an entity (that is, that the co-ownership may not file a
partnership or corporate tax return, conduct business under a common name,
execute an agreement identifying any or all of the co-owners as partners,
shareholders, or members of a business entity, or otherwise hold itself out as
a partnership or other form of business entity), and a requirement that certain
rights with respect to the property (including the power to make certain
management decisions) must be retained by co-owners. The revenue procedure provides
that an organization that is an entity for state law purposes may not be
characterized as a co-ownership under the guidance in the revenue procedure.
The courts and
the IRS have addressed the Federal tax classification of investment trusts with
assets divided among a number of series. In National Securities
Series-Industrial Stocks Series v. Commissioner, 13 T.C. 884 (1949), acq.,
1950-1 C.B. 4, several series that differed only in the nature of their assets
were created within a statutory open-end investment trust. Each series
regularly issued certificates representing shares in the property held in trust
and regularly redeemed the certificates solely from the assets and earnings of
the individual series. The Tax Court stated that each series of the trust was
taxable as a separate regulated investment company. See also Rev. Rul. 55-416,
1955-1 C.B. 416, (see §601.601(d)(2)(ii)(b)). But see Union Trusteed
Funds v. Commissioner, 8 T.C. 1133 (1947), (series funds organized by a
state law corporation could not be treated as if each fund were a separate
corporation).
In 1986, Congress
added section 851(g) to the Code. Section 851(g) contains a special rule for
series funds and provides that, in the case of a regulated investment company
(within the meaning of section 851(a)) with more than one fund, each fund
generally is treated as a separate corporation. For these purposes, a fund is a
segregated portfolio of assets the beneficial interests in which are owned by
holders of interests in the regulated investment company that are preferred
over other classes or series with respect to these assets.
C. Insurance company classification
Section
7701(a)(3) and §301.7701-2(b)(4) provide that an arrangement that qualifies as
an insurance company is a corporation for Federal income tax purposes. Sections
816(a) and 831(c) define an insurance company as any company more than half the
business of which during the taxable year is the issuing of insurance or
annuity contracts or the reinsuring of risks underwritten by insurance
companies. See also §1.801-3(a)(1), (“[T]hough its name, charter powers, and
subjection to State insurance laws are significant in determining the business
which a company is authorized and intends to carry on, it is the character of
the business actually done in the taxable year which determines whether a
company is taxable as an insurance company under the Internal Revenue Code.”).
Thus, an insurance company includes an arrangement that conducts insurance
business, whether or not the arrangement is a state law entity.
3. Overview of Series LLC Statutes and Cell Company Statutes
Although
§301.7701-1(a)(1) provides that state classification of an entity is not
controlling for Federal tax purposes, the characteristics of series LLCs and
cell companies under their governing statutes are an important factor in
analyzing whether series and cells generally should be treated as separate entities
for Federal tax purposes.
Series LLC
statutes have been enacted in Delaware, Illinois, Iowa, Nevada, Oklahoma,
Tennessee, Texas, Utah and Puerto Rico. Delaware enacted the first series LLC
statute in 1996. Del. Code Ann. Tit. 6, section 18-215 (the Delaware statute).
Statutes enacted subsequently by other states are similar, but not identical,
to the Delaware statute. All of the statutes provide a significant degree of
separateness for individual series within a series LLC, but none provides series
with all of the attributes of a typical state law entity, such as an ordinary
limited liability company. Individual series generally are not treated as
separate entities for state law purposes. However, in certain states (currently
Illinois and Iowa), a series is treated as a separate entity to the extent
provided in the series LLC’s articles of organization.
The Delaware
statute provides that a limited liability company may establish, or provide for
the establishment of, one or more designated series of members, managers, LLC
interests or assets. Under the Delaware statute, any such series may have
separate rights, powers, or duties with respect to specified property or
obligations of the LLC or profits and losses associated with specified property
or obligations, and any such series may have a separate business purpose or
investment objective. Additionally, the Delaware statute provides that the
debts, liabilities, obligations, and expenses of a particular series are
enforceable against the assets of that series only, and not against the assets
of the series LLC generally or any other series of the LLC, and, unless the LLC
agreement provides otherwise, none of the debts, liabilities, obligations, and
expenses of the series LLC generally or of any other series of the series LLC
are enforceable against the assets of the series, provided that the following
requirements are met: (1) the LLC agreement establishes or provides for the
establishment of one or more series; (2) records maintained for any such series
account for the assets of the series separately from the other assets of the
series LLC, or of any other series of the series LLC; (3) the LLC agreement so
provides; and (4) notice of the limitation on liabilities of a series is set
forth in the series LLC’s certificate of formation.
Unless otherwise
provided in the LLC agreement, a series established under Delaware law has the
power and capacity to, in its own name, contract, hold title to assets, grant
liens and security interests, and sue and be sued. A series may be managed by
the members of the series or by a manager. Any event that causes a manager to
cease to be a manager with respect to a series will not, in itself, cause the
manager to cease to be a manager of the LLC or of any other series of the LLC.
Under the
Delaware statute, unless the LLC agreement provides otherwise, any event that
causes a member to cease to be associated with a series will not, in itself,
cause the member to cease to be associated with any other series or with the
LLC, or cause termination of the series, even if there are no remaining members
of the series. Additionally, the Delaware statute allows a series to be
terminated and its affairs wound up without causing the dissolution of the LLC.
However, all series of the LLC terminate when the LLC dissolves. Finally, under
the Delaware statute, a series generally may not make a distribution to the
extent that the distribution will cause the liabilities of the series to exceed
the fair market value of the series’ assets.
The series LLC
statutes of Illinois, 805 ILCS 180/37-40 (the Illinois statute), and Iowa,
I.C.A. §489.1201 (the Iowa statute) provide that a series with limited
liability will be treated as a separate entity to the extent set forth in the
articles of organization. The Illinois statute provides that the LLC and any of
its series may elect to consolidate their operations as a single taxpayer to
the extent permitted under applicable law, elect to work cooperatively, elect
to contract jointly, or elect to be treated as a single business for purposes
of qualification to do business in Illinois or any other state.
In addition,
under the Illinois statute, a series’ existence begins upon filing of a
certificate of designation with the Illinois secretary of state. A certificate
of designation must be filed for each series that is to have limited liability.
The name of a series with limited liability must contain the entire name of the
LLC and be distinguishable from the names of the other series of the LLC. If
different from the LLC, the certificate of designation for each series must
list the names of the members if the series is member-managed or the names of
the managers if the series is manager-managed. The Iowa and Illinois statutes
both provide that, unless modified by the series LLC provisions, the provisions
generally applicable to LLCs and their managers, members, and transferees are
applicable to each series.
Some states have
enacted series provisions outside of LLC statutes. For example, Delaware has
enacted series limited partnership provisions (6 Del. C. §17-218). In addition,
Delaware’s statutory trust statute permits a statutory trust to establish
series (12 Del. C. §3804). Both of these statutes contain provisions that are
nearly identical to the corresponding provisions of the Delaware series LLC
statute with respect to the ability of the limited partnership or trust to
create or establish separate series with the same liability protection enjoyed
by series of a Delaware series LLC.
All of the series
LLC statutes contain provisions that grant series certain attributes of
separate entities. For example, individual series may have separate business
purposes, investment objectives, members, and managers. Assets of a particular
series are not subject to the claims of creditors of other series of the series
LLC or of the series LLC itself, provided that certain record-keeping and
notice requirements are observed. Finally, most series LLC statutes provide
that an event that causes a member to cease to be associated with a series does
not cause the member to cease to be associated with the series LLC or any other
series of the series LLC.
However, all of
the state statutes limit the powers of series of series LLCs. For example, a
series of a series LLC may not convert into another type of entity, merge with
another entity, or domesticate in another state independent from the series
LLC. Several of the series LLC statutes do not expressly address a series’
ability to sue or be sued, hold title to property, or contract in its own name.
Ordinary LLCs and series LLCs generally may exercise these rights.
Additionally, most of the series LLC statutes provide that the dissolution of a
series LLC will cause the termination of each of its series.
B. Statutes with respect to insurance
The insurance
codes of a number of states include statutes that provide for the chartering of
a legal entity commonly known as a protected cell company, segregated account
company, or segregated portfolio company. See, for example, Vt. Stat. Ann. tit.
8, chap.141, §§6031-6038 (sponsored captive insurance companies and protected
cells of such companies); S.C. Code Ann. tit. 38, chap. 10, §§38-10-10 through
39-10-80 (protected cell insurance companies). Under those statutes, as under
the series LLC statutes described above, the assets of each cell are segregated
from the assets of any other cell. The cell may issue insurance or annuity
contracts, reinsure such contracts, or facilitate the securitization of
obligations of a sponsoring insurance company. Rev. Rul. 2008-8, 2008-1 C.B.
340, (see §601.601(d)(2)(ii)(b)), analyzes whether an arrangement
entered into between a protected cell and its owner possesses the requisite
risk shifting and risk distribution to qualify as insurance for Federal income
tax purposes. Under certain domestic insurance codes, the sponsor may be
organized under a corporate or unincorporated entity statute.
Series or cell
company statutes in a number of foreign jurisdictions allow series or cells to
engage in insurance businesses. See, for example, The Companies (Guernsey) Law,
2008 Part XXVII (Protected Cell Companies), Part XXVIII (Incorporated Cell Companies);
The Companies (Jersey) law, 1991, Part 18D; Companies Law, Part XIV (2009
Revision) (Cayman Isl.) (Segregated Portfolio Companies); and Segregated
Accounts Companies Act (2000) (Bermuda).
The information provided herein is not intended as
legal, accounting, financial or any type of advice for any specific individual
or other entity. You should contact an appropriate professional for any such
advice.
