State Tax Treatment of LLCs and LLPs: Update for 2013
The charts include entity-level taxes, state conformity with the federal entity classification rules, and potential entity-level withholding requirements, as well as certain nontax elements, such as restrictions on the availability of entity forms for certain professionals.
Many factors should be considered when deciding how to structure a business entity, and state taxation cannot be overlooked. The following pages contain the most recent (as of 3/1/13) edition of our LLC/LLP state tax charts, which were last published in The Journal in the March/April 2012 issue. These charts can assist in evaluating the use of limited liability companies (LLCs) and limited liability partnerships (LLPs), particularly in a multistate context.
Over the years, LLCs and, to a lesser extent, LLPs have become popular choices for structuring or re-structuring multistate business entities. The accompanying charts set out the various differences in the way the 50 states and the District of Columbia treat LLCs and LLPs that do not elect to be taxed as either "C" corporations or "S" corporations. The charts discuss state tax considerations, such as entity-level taxes, conformity with the federal entity classification rules for income tax purposes, and potential entity-level withholding requirements, as well as certain nontax elements, such as restrictions on the availability of entity forms for certain professionals and the extent of liability protection afforded to partners of LLPs.
Investment partnerships We trust that readers also will find the footnotes to be useful, in particular the one noting the growing number of states that now officially exempt partners' distributive shares of income from qualified investment partnerships. A qualified investment partnership (QIP) generally is a pass-through entity substantially all of whose income is derived from investments that produce income that would not be taxable to a nonresident individual if the investments were held or owned individually (i.e., investments in intangible property not used in a trade or business). (For more on QIPs, see, e.g., Gotlinger and Mahon, "State Tax Exemptions for Investment Partnerships and Their Nonresident Partners," 17 JMT 22 (February 2008).)
Series LLCs Also, with the growing popularity of series LLCs, we have added a new column to the charts to highlight which states have enacted series LLC statutes and which state taxing authorities have issued guidance on how their states will tax these odd creatures. A series LLC allows for the establishment of separate LLC interests with regard to, e.g., specified LLC property or obligations, thus facilitating separate liability exposure without creating separate legal entities. (For more on series LLCs, see, e.g., McLoughlin and Ely, "The Series LLC Raises Serious State Tax Questions but Few Answers Are Yet Available," 16 JMT 6 (January 2007).)
Series LLC guidance at the federal level In September 2010, the U.S. Treasury Department issued, in the form of proposed regulations, its long-awaited guidance on the treatment of series LLCs for federal income tax purposes. (See REG-119921-09, filed 9/13/10, published 9/14/10 (F.R. Doc. 2010-22793; 75 Fed. Reg. 55699 et seq.), adding Prop. Treas. Regs. §§301.6011-6, 301.6071-2, and 301.7701-1(a)(5), and amending §§301.7701-1(e) and (f). For a detailed analysis of the proposed series LLC regulations and the related state tax implications, see McLoughlin and Ely, "IRS Issues Long-Awaited Guidance on Series LLCs; Will the States Soon Follow?," 20 JMT 8 (January 2011).)
Consistent with previous rulings by the IRS, the proposed regulations generally treat each series of an LLC as a separate entity and apply the check-the-box entity classification provisions to each series. Once Treasury finalizes these regulations (and we hope and expect that to occur this year), we anticipate that a number of states will enact legislation authorizing the formation or qualification of these relatively new hybrid entities, and that a large number of states will publish some form of guidance on how each series and the "mother ship" LLC itself are to be treated for purposes of a variety of state taxes, including unemployment compensation taxes or premiums.
Another of our senior associates at Bradley Arant Boult Cummings LLP, James E. Long, Jr., co-chairs a joint task force of the American Bar Association Tax Section's Partnerships Committee and State and Local Tax Committee that has prepared a draft report summarizing the responses of approximately 30 states to a questionnaire the task force prepared to facilitate that guidance to taxpayers and practitioners. We expect the official report to be released at around the time of the Tax Section's annual May meeting in Washington, D.C.
Finally, the state legislatures and departments of revenue always try to be one step ahead of the authors. We therefore welcome and always appreciate updates from our readers.
“This article appears in and is reproduced with the permission of the Journal of Multistate Taxation and Incentives, Vol. 23, No. 2, May 2013. Published by Warren, Gorham & Lamont, an imprint of Thomson Reuters.”