State Tax Treatment of LLCs and LLPs: Update for 2014

Journal of Multistate Taxation and Incentives

Authored Article

Author(s) ,

Volume 24, Number 2, May 2014
Department: S CORPORATIONS, PARTNERSHIPS, AND LLCs

The charts cover entity-level taxes, state conformity with the federal entity classification rules, and potential entity-level withholding or composite return requirements, as well as various nontax elements, such as restrictions on the availability of entity forms for certain professionals.

By: BRUCE P. ELY, WILLIAM T. THISTLE, II, AND J. SIMS RHYNE III

BRUCE P. ELY is a partner in the Birmingham, Alabama office of the multistate law firm of Bradley Arant Boult Cummings LLP, and chairs the firm's State & Local Tax Practice Group. He can be reached via e-mail at bely@bradley.com. WILLIAM T. THISTLE, II and J. SIMS RHYNE III are associates with the same law firm, also resident in Birmingham. They may be reached via e-mail at, respectively, wthistle@bradley.com and srhyne@bradley.com. The authors are frequent contributors to The Journal. They welcome legislative and regulatory updates from readers. Copyright © February 14, 2014, Bruce P. Ely / William T. Thistle, II / J. Sims Rhyne III. This article appears in and is reproduced with the permission of the Journal of Multistate Taxation and Incentives, Vol. 24, No. 2, May 2014. Published by Warren, Gorham & Lamont, an imprint of Thomson Reuters.

The owners of multistate businesses must consider a multitude of factors when deciding how to structure their business ventures, and, of course, state taxation cannot be overlooked. The following pages contain the most recent (as of 1/1/14) edition of our LLC/LLP state tax charts, which were last published in The Journal in the May 2013 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 first chart discusses state tax considerations, such as conformity with the federal entity classification rules for income tax purposes, entity-level taxes, and potential entity-level withholding or composite return 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.

The second chart lists the states that impose a net-worth- or debt-based corporate franchise tax, and which of those states either subject LLCs, LPs, and LLPs to such tax or exempt those entities, as of 1/1/14. While we hope that each of these charts is a useful research tool, they are only a starting point.

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 recognize qualified investment partnerships and exempt them and/or their nonresident partners from state income tax and nonresident partner withholding. 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 J. Multistate Tax’n 22 (February 2008).)

Series LLCs. Like LLCs, the use of series LLCs to structure a multistate business has grown in popularity in recent years. To that end, the last column of the first chart now highlights which states have enacted series LLCs statutes and which state taxing authorities have issued guidance on how their states will tax these odd creatures. It reflects helpful input from the AICPA's State Tax Resource Panel (TRP).

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 J. Multistate Tax’n 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 explaining how a series LLC would be treated 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 J. Multistate Tax’n 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 expect that to occur by this summer), 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. In that regard but not waiting for further Treasury/IRS action, as we went to press Alabama enacted a new LLC law (Alabama Limited Liability Company Law of 2014 (H.B. 2, 3/11/14; Act. No. 2014-144; generally eff. 1/1/15)) that, in new Ala. Code §10A-5A-11.01 et seq., provides for the formation and recognition of series LLCs. This legislation also is noted in the accompanying chart.

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 (ABA) Tax Section's Partnerships Committee and State and Local Tax Committee that has prepared a comprehensive report summarizing the responses of approximately 30 states to a questionnaire the task force prepared to facilitate that guidance to taxpayers and practitioners and to the Internal Revenue Service. The official report was released by the ABA Tax Section on 4/30/13. A summary of the Series LLC Task Force's report is available via the ABA website.

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.

 

Exhibit 1. State Tax Treatment of Limited Liability Companies and Limited Liability Partnerships (as of 1/1/14)

 

Exhibit 2. Tax Treatment of LLCs/LLPs/LPs (LLEs) by States Imposing Net Worth- or Debt-Based Corporate Franchise Taxes (as of 1/1/14)

© 2014 Thomson Reuters/Tax & Accounting. All Rights Reserved. This article appears in and is reproduced with the permission of the Journal of Multistate Taxation and Incentives, Vol. 24, No. 2, May 2014. Published by Warren, Gorham & Lamont, an imprint of Thomson Reuters.