Wednesday, March 7, 2012

Disregarded entities cannot have multiple interests

Doeren Mayhew 

Disregarded entities cannot have multiple interests

Limited liability companies (LLCs) are becoming more popular. If the LLC has only one owner, the owner can elect whether to treat the LLC as a disregarded entity (DE) for federal tax purposes or as an association taxable as a corporation. DE treatment for the LLC may be particularly appealing because the owner has the benefit of passthrough taxation, like a partnership, but with limited liability, like a corporation. With only one interest outstanding, the DE generally has a simplified ownership structure.

An IRS Chief Counsel memorandum has now addressed the situation where a taxpayer established a DE with multiple ownership interests under state law. The DE split its ownership interest into separate classes of membership interests. However, the sole owner retained ownership of all interests.

The DE then allocated income, loss, deduction, credit and basis among the classes of interests, for federal tax purposes. By doing this, the owner attempted to create an "outside" basis in the DE and to control the
recognition of income or loss from distributions by the entity or dispositions of an interest in the entity.

Chief Counsel concluded that the multiple interests have no effect under federal tax law. The owner does not own a separate class of interests in the DE. Instead, the owner is treated as directly owning each of the DE's assets, like a sole proprietorship, branch, or division of the owner.

A DE cannot have multiple interests for tax purposes. The owner already owns all of the DE's property. Attempts to allocate items to the owner's different interests have no meaning under federal tax law, when the same person owns 100 percent of all classes of interests. A distribution by the entity, or the "disposition" of an interest in the entity, has no independent significance.

LLCs, nevertheless, remain an excellent form of ownership for many single-owner businesses, providing significant tax planning opportunities. Our office is here to advise you on what can and cannot be done.

Contact Doeren Mayhew for more information.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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