Читать книгу Taxation Essentials of LLCs and Partnerships - Larry Tunnell - Страница 21

Prior to 1997, entities had to satisfy the cumbersome and highly complex requirements of Reg. Sec. 301.7701 to be classified as partnerships for federal income tax purposes. These regulations required that the entity could not be taxed as a partnership if it possessed more than two of a list of four so-called “corporate” characteristics (limited liability, unlimited life, free transferability of interests, and centralized management).⁶ However, the criteria were rendered largely meaningless by the numerous exceptions and limitations imposed in the regulations, so that entities that truly wished to be taxed as partnerships could write their partnership agreements in such a way that partnership status was virtually guaranteed. The result was that the regulations served principally as a trap for the unwary.

To simplify the classification process, and to eliminate the potential that taxpayers who thought they were operating as legitimate partnerships would be subjected to onerous penalties upon discovering that they did not satisfy the technical criteria of the regulations, the IRS in 1996 implemented new rules under which eligible entities will be classified as partnerships unless they file Form 8832, Entity Classification Election, and elect to be classified as a corporation or different type of entity.⁷ These rules remove any uncertainty about the classification process, and are particularly helpful for limited liability companies, which may freely choose between being taxed as either partnerships or corporations (including S corporations). Uncertainty is further reduced by Reg. Sec. 301.7701-3(b)(1)(i), which provides that in the event an entity neglects to properly file an election, the default classification for domestic entities with at least two members is a partnership. Such entities will automatically be treated as partnerships for federal income tax purposes unless they elect to be classified as a different type of entity.⁸ Further reducing uncertainty is the rule that any entity that is incorporated under state law is treated as a corporation for tax purposes. If that entity wants some of the benefits of having its income pass through to the shareholders, it can elect S corporation status.

Moreover, the regulations provide that the entity choice election is not permanent. Once an entity elects its tax status, it retains such status so long as it does not make an election to change to a different status. Revised status generally cannot be elected during the 60-month period following the previous election, although the commissioner is authorized to permit a change in status if more than 50% of the ownership interests in the entity as of the effective date of the subsequent election are owned by persons that did not own any interests in the entity on the filing date or on the effective date of the entity's prior election.

Therefore, an LLC can elect to be taxed as a partnership for the first five years of its life and then change its status to a corporation for federal income tax purposes thereafter. It is important to recognize, however, that a change in status will not necessarily be tax free. The regulations treat the election to change an entity's status as a liquidation of the old entity accompanied by the formation of a new one.⁹ In the case of a partnership electing to be taxed as a corporation, the regulations treat the partnership as if it transferred all its assets and liabilities to a newly formed corporation (requiring a new taxpayer identification number) in exchange for stock, and then liquidated, distributing the corporate stock to its partners. Because liquidation of a partnership is generally a tax-free transaction, this deemed transaction will seldom have any tax consequences for the members.¹⁰