On September 13, the IRS released proposed regulations (REG-119921-09) on the tax treatment of series limited liability companies (LLCs) and foreign cell companies, proposing to treat the individual series or cells as separate entities for tax purposes.
Eight states and Puerto Rico have enacted series LLC statutes that allow an LLC to establish separate “series” within it. The series are not separate legal entities, but each series has associated with it specified members of the LLC, as well as specified assets, rights, obligations, and investment objectives or business purposes. Being associated with a series is thus comparable to direct ownership of the series. Under series LLC statutes, the debts, liabilities, and obligations of one series are generally enforceable only against the assets of that series and not against assets of other series or of the series LLC. (For more on this topic, see Walberg and Hanson, “Series LLCs in Business and Tax Planning,” 41 The Tax Adviser 50 (January 2010).)
Some jurisdictions have established similar entities known variously as protected cell companies, segregated account companies, or segregated portfolio companies (cell companies). A cell company may establish multiple cells, each of which has its own name and is identified with a specific participant, but each cell 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.
There has been little guidance on the federal tax treatment of series LLCs and similar entities, and in Notice 2008-19 the IRS asked for comments on series LLC issues in general and specifically on issues that arise when arrangements entered into by a cell constitute insurance for federal income tax purposes. The comments the IRS received generally recommended that series and cells should be treated as separate entities for federal tax purposes, and the IRS in its proposed regulations has generally agreed to treat them that way.
The proposed regulations provide that, for federal tax purposes, a domestic series will be treated as an entity formed under local law, whether or not local law treats the series as a separate legal entity. The tax treatment of the series will then be governed by the check-the-box regulations (Regs. Secs. 301.7701-1 through 301.7701-3).
The IRS considered automatically treating series as disregarded entities because they are generally not considered separate entities for local law purposes. However, the IRS decided that the factors supporting separate entity status for series outweigh the factors in favor of disregarding series as entities separate from the series LLC and other series of the series LLC. It specifically looked at the fact that the rights, duties, and powers of members associated with a series are direct and specifically identified. It also noted that individual series may have separate business purposes and investment objectives. The IRS concluded that these factors are sufficient to treat domestic series as entities formed under local law.
The proposed regulations do not address the entity status for federal tax purposes of the series LLC itself, just the series within it. Specifically, the proposed regulations do not address whether a series LLC is recognized as a separate entity for federal tax purposes if it has no assets and engages in no activities independent of its series.
The tax treatment proposed in the regulations does not apply to series or cells organized under foreign laws, except for foreign series that engage in an insurance business. The proposed regulations define the term “series” to include a cell, segregated account, or segregated portfolio that is formed under the insurance code of a jurisdiction or is engaged in an insurance business (other than a segregated asset account of a life insurance company). A series that is organized or established under the laws of a foreign jurisdiction is treated as an entity if the arrangements and other activities of the series, if conducted by a domestic company, would result in its being classified as an insurance company.
Because the series LLC or a series of the series LLC may be treated as a separate entity for federal tax and related reporting purposes but may not be a separate entity under local law, the proposed regulations say that the IRS will create a new statement that series LLCs and each series will be required to file annually to provide the IRS with certain identifying information to ensure the proper assessment and collection of tax.
The proposed regulations will be effective when finalized. The IRS warns that taxpayers who currently treat series differently for federal tax purposes than series are treated under the final regulations will be required to change their treatment of the series. Specifically, a series LLC that previously was treated as one entity with all of its series may be required to begin treating each series as a separate entity for federal tax purposes.