Indiana Series LLCs, Part VII: Income Taxation

Earlier articles on the topic of Indiana series LLCs are here:

Part I, Basic concepts and terminology
Part II, Is a series an entity?
Part III, What constitutes a series?
Part IV, Setting up an Indiana series LLC
Part V, Operating agreements for Indiana series LLCs
Part VI, Alternatives for ownership structure

In this one, we look at federal income taxation of series LLCs.

For several years after the first series LLC statute, it was an open question whether a series LLC is to be taxed as a single, consolidated entity or each series is to be taxed separately.  In 2010, the Internal Revenue Service answered the question through a proposed rule, 75 Fed. Reg. 55,699 (Sept. 14, 2010), 2010-45 I.R.B., that can be relied on even though it has yet to be finalized.

At the time the IRS issued its proposed rule, series LLC statutes had been enacted in eight states plus Puerto Rico.  In analyzing the statutes, the IRS concluded that under all the statutes series have some, but not all, of the attributes of a separate entity and noted that only two (those of Illinois and Iowa) expressly provide that a series is to be treated as a separate entity.  However, the IRS is not prohibited from treating a series as an entity distinct from its owners for federal tax purposes, even if it is not treated as a separate entity under state law.  As explained in the preamble to the proposed rule,

[Treasury Regulation] 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.

75 Fed. Reg. at 55,699-700.  Similarly, the IRS is not obligated to treat every organization that is a separate entity under state law as an entity distinct from its owns for federal tax purposes.

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.

75 Fed. Reg. at 55,700. Accordingly, Prop. Treas. Reg. § 377.7701-1(a)(5)(viii) contains a set of definitions that determine whether a series as defined by state law is to be treated as an entity distinct from its owners for federal tax purposes.

First, Prop. Treas. Reg. § 377.7701-1(a)(5)(viii)(B) defines a “series statute.”

A series statute is a statute of a State or foreign jurisdiction that explicitly provides for the organization or establishment of a series of a juridical person and explicitly permits—

(1) Members or participants of a series organization to have rights, powers, or duties with respect to the series;

(2) A series to have separate rights, powers, or duties with respect to specified property or obligations; and

(3) The segregation of assets and liabilities such that none of the debts and liabilities of the series organization (other than liabilities to the State or foreign jurisdiction related to the organization or operation of the series organization, such as franchise fees or administrative costs) or of any other series of the series organization are enforceable against the assets of a particular series of the series organization.

Second, “series organization” is defined by Prop. Treas. Reg. § 377.7701-1(a)(5)(viii)(A).

A series organization is a juridical entity that establishes and maintains, or under which is established and maintained, a series (as defined [below]). A series organization includes a series limited liability company, series partnership, series trust, protected cell company, segregated cell company, segregated portfolio company, or segregated account company.

Finally, Prop. Treas. Reg. § 377.7701-1(a)(5)(viii)(C) provides the federal definition of “series.”

A series is a segregated group of assets and liabilities that is established pursuant to a series statute…by agreement of a series organization…. An election, agreement, or other arrangement that permits debts and liabilities of other series or the series organization to be enforceable against the assets of a particular series, or a failure to comply with the record keeping requirements for the limitation on liability available under the relevant series statute, will be disregarded for purposes of this [definition].

The proposed rule provides that each series, as defined above,

  • Is treated as an entity apart from its owners for federal tax purposes;
  • Makes its own, independent election of tax status under the “check-the-box” regulation; and
  • Is not responsible for the federal income tax obligations associated with any other series.

The “check-the-box” regulation means that each series with more than one member can elect to be taxed as a partnership, as a corporation under Subchapter C, or as a corporation under Subchapter S (if the members of the series satisfy the restrictions on S-corp shareholders).  If the series has only one member, the choices are disregarded entity, C-corp, or S-corp.  Although the proposed rule does not specifically address the issue, it seems that each series needs its own tax identification number and that each series that does not accept the default classification of partnership (or disregarded entity) must file its own Form 8832 (to elect C-corp status) or Form 2553 (to elect S-Corp status).

It is apparent from the above definitions and discussion that the Indiana series LLC statute is a “series statute,” that a master LLC under Indiana law is a “series organization,” and that a series as defined by the Indiana statute is also a “series” for federal tax purposes.  According, the above principles apply to each series in an Indiana series LLC.

Nonetheless, the proposed rule leaves other questions unanswered.  Although it provides that a series is to be treated as an entity distinct from its owners, it does not address the status of the series organization itself. However, the preamble recognizes that series organizations are generally considered to be separate entities under both state law and federal tax law. Accordingly, it appears likely that a master LLC is to be treated as an entity separate from its owners and separate from its series.  Note, however, that under some structures, such as Structure #2 described in Part VI, the master LLC will have no income, deductions, or credits. If so, and if the master LLC is taxed as a partnership (the default status for LLCs), it will have no obligation to file tax returns.   75 Fed. Reg. at 55,704.

The final post on Indiana series LLCs will discuss other unanswered questions and uncertainties.

[Revised 9/15/2016 to include information on obtaining tax identification numbers and filing forms to elect S-corp or C-corp status.]


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