Category: Partnerships & LLCs Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Taxpayer is a single-member limited liability company (LLC). The issue is how does the taxpayer fit within the new so-called "check-the-box" entity classification rules and what type of tax return is used to report the activities of this entity. New entity classification rules were finalized in December, 1996 to supplant the existing rules issued in 1960. These new rules eliminate the need to determine whether an unincorporated entity has an predominance of corporate characteristics and is thus treated as an association taxed as a corporation; or in the alternative, the entity should be taxed as a partnership. These new rules were issued in response to the widespread use of limited liability companies which blurred the traditional lines between an association and a partnership. The new regulations, Reg. Secs. 301-7701-1 through 5, in effect provide a tiered approach to entity classification. Tier One (1) A business entity organized under a Federal or State statute, or under a statute of a federally recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate, or body politic; (2) An association (as determined under §301.7701-3); (3) A business entity organized under a State statute, if the statute describes or refers to the entity as a joint-stock company or joint-stock association; (4) An insurance company; (5) A State-chartered business entity conducting banking activities, if any of its deposits are insured under the Federal Deposit Insurance Act, as amended, 12 U.S.C. 1811 et seq., or a similar federal statute; (6) A business entity wholly owned by a State or any political subdivision thereof; (7) A business entity that is taxable as a corporation under a provision of the Internal Revenue Code other than section 7701(a)(3); and (8) Certain foreign entities. (i) In general. Except as provided in paragraphs (b)(8)(ii) and (d) of this section, the following business entities formed in the following jurisdictions: (I have omitted this list because it is lengthy and irrelevant to this particular matter.) Clearly, a single-member LLC does not fit under any of the categories set forth above. Apparently, the second category above, an association (as determined under §301.7701-3), simply refers to the situation in which an entity has elected to be treated as an association under §301.7701-3. Accordingly, there is no reason to force corporate classification on a single-member LLC pursuant to the first tier rules. Tier Two Under the default classification rules, an entity that is not a corporation under the rules set forth at Reg. Section 301.7701-2, the Tier One rules, is treated as: 1) a partnership if the entity has two or more owners; or 2) disregarded as a separate entity if there is only one owner. The results set forth above assume that the entity is not a trust. If a taxpayer does not want the default classification, then a contrary election can be made on Form 8823. Under Reg. Section 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. ********* The ultimate practical question in play here is how does one file a tax return for a single-member LLC. I think the simple statement set forth at Reg. Section 301.7701-2(a) definitively answers that question: the activities of such an entity, assuming that it has not elected to be taxed as an association (i.e., a corporation), are treated in the same manner as a sole proprietorship (if the sole member is an individual) or otherwise as a branch or division of the sole member. If the entity is disregarded, then the activities should be reported as if they were the activities of the sole member, in this case the individual taxpayer. To me, it is very clear that for a single-member LLC, all this simply means to use a Schedule C as if there were no LLC in the first place. As a practical matter, I would disclose the existence of the LLC when listing the name of the business on the Schedule C. One other practical consideration of some significance is the treatment of the LLC for state tax purposes. It would be unwise to take for granted that the state in which the LLC is located accepts these new federal regulations even if the state uses the U.S. Internal Revenue Code as its starting point. California has recently announced that it will not follow the new rules. Other states make take similar positions. This matter should be looked into for the state in question.
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