Recent Rulings on “Family Limited Liability Entity” Election Create Traps for the Unwary

State & Local Tax Alert: Alabama Edition

Client Alert

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Although every LLC, limited partnership or other pass-through entity doing business in Alabama, and even those simply organized under Alabama law, are subject to an annual business privilege tax (BPT), certain entities can substantially limit their BPT liability by electing treatment as a “Family Limited Liability Entity” pursuant to Ala. Code § 40-14A-22(d)(2). If certain requirements are met, an electing Family LLE qualifies for a reduced maximum BPT of $500 a year. However, in light of two rulings issued recently by the Alabama Tax Tribunal (ATT), those preparing--or simply filing--BPT returns for entities claiming to be Family LLEs should pay close attention to the statutory qualifications and election procedure for these entities. For what grace the Alabama Department of Revenue (ADOR) previously bestowed on arguably deficient filings seems to have been withdrawn…

The first case, Wilson Investment Co., LLC v. ADOR, focused on the requisite qualifications for Family LLE treatment. The taxpayer timely filed its 2009, 2012, and 2014 Alabama BPT returns making the Family LLE election and dutifully reporting $500 of tax for each year. The taxpayer’s election form stated that it was directly or constructively owned by an individual and her four children, and therefore met the statutory requirements. The ADOR, however, contended that the taxpayer did not qualify for Family LLE treatment because it was solely owned by the individual, after applying constructive ownership/attribution rules. 

On appeal, the Tax Tribunal held that the taxpayer did, in fact, qualify for Family LLE status in the 2009 tax year, but not for either the 2012 or 2014 tax year. Associate Judge Christy Edwards first noted that under Ala. Code § 40-14A-1(h), an entity doesn’t qualify for the Family LLE election unless at least 80 percent of its profits and capital interests are directly or constructively owned by an individual and one or more members of that individual’s “family.” Judge Edwards found that for the 2009 tax year, the taxpayer was owned by an individual and her four children, and thus the entity qualified as a Family LLE.

Not so for the 2012 and 2014 tax years. In those years, 1 percent of the LLC was instead owned by a marital trust established for the benefit of the individual and 99 percent by an irrevocable grantor trust also “owned” by the individual. Applying the ownership attribution rules of IRC § 318(a), the ATT agreed with the ADOR that the taxpayer was owned entirely by the individual. The ATT also rejected the taxpayer's alternate argument that the applicable law should be interpreted as allowing an entity to qualify for Family LLE status so long as one individual owned at least 80 percent of the entity. According to the ATT, that contention didn’t comport with the plain language of the statute (individual and family members) or the generally understood rules of statutory construction.

The second case, Harris Investments, LTD v. ADOR, focused on the procedures that entities and their return preparers must follow to properly make the Family LLE election. In that case, the taxpayer-limited partnership timely filed its 2016 Alabama BPT return, claiming the Family LLE election and paying tax in the amount of $500. The taxpayer, however, failed to check the box on line 17 of its BPT return labeled “Family LLE Election attached.” The ADOR also argued that the taxpayer’s CPA didn’t attach the required Family LLE election form, Form BPT-E, either.    

On appeal, the taxpayer didn’t dispute that the Family LLE election box on line 17 was not checked.  Instead, the taxpayer argued that the ADOR should grant an abatement of tax because the LP had elected treatment as a Family LLE for numerous years prior to 2016, and this was the first time the taxpayer had failed to check the box. The taxpayer also contended that the Family LLE election was properly claimed because the CPA had attached the Form BPT-E to its original 2016 return, and had resubmitted a copy of the election form after the ADOR claimed it had not been attached when received.

The ATT, however, did not find the taxpayer’s arguments convincing. The ATT began its analysis by stating that the taxpayer failed to offer any evidence that a BPT-E election form was included with the original return, as required by ADOR Rule 810-2-8-.05. Pointing to the regulation, the judge explained that to be considered an electing Family LLE, a completed Form BPT-E must be attached to the subject year’s original return, which must be filed on or before the return date.  Relying on its own precedent in B&B Enterprises, LLC v. ADOR, Ala., Dkt. No. BPT. 14-439 (Jan. 30, 2015), the ATT concluded that although the consequences may sometimes be harsh, failing to make the Family LLE election precisely in accordance with the manner prescribed by the regulation results in the loss of Family LLE status. The ATT affirmed the ADOR’s assessment of the additional BPT tax.

In light of these recent rulings, the ADOR and the ATT have clearly indicated that Family LLE status will only be given to entities that qualify and timely make the election in strict accordance with the relevant statutory authority and regulations. Those assisting in preparing BPT returns should be mindful of these conditions, and promptly conduct a review of the ownership structure of their Family LLE clients with a focus on the IRC § 318 constructive ownership rules, especially when ownership is through one or more trusts.

*Thanks to our law clerk, Matt Hambrick, a third-year law student at Cumberland School of Law at Samford University, for his assistance in preparing this alert. © October 2017. Bruce P. Ely/James E. Long, Jr. All rights reserved.