Why is this Topic Important to Wealth Managers? Discusses proposed regulations regarding use of alternative business entity structures with regards to Federal tax purposes.  Informs wealth managers of the trends the Government is seemingly following regarding separate entity taxation for series and cell companies.

Late last year the IRS published proposed regulations regarding the classification for Federal tax purposes a domestic series limited liability company (LLC), a domestic cell company, or a foreign series or cell that conducts an insurance business. [1]

A number of States, such as Delaware, have enacted statutes providing for the creation of entities that may establish series, including limited liability companies (series LLCs).[2] In general, most series LLC statutes provide that a limited liability company may establish separate series.

Although the series LLC generally are not treated as separate entities for State law purposes, the treatment of rights and obligations is similar to separate entities, creating in essence “associated members”.  Members’ association with one or more particular series is comparable to direct ownership by the members in such series, in that their rights, duties, and powers with respect to the series are direct and specifically identified.   If the conditions enumerated in the relevant statute are satisfied, the debts, liabilities, and obligations of one series generally are enforceable only against the assets of that series and not against assets of other series or of the series LLC.

Certain jurisdictions have enacted statutes providing for entities similar to the series LLC.  For example, certain statutes provide for the chartering of a legal entity (or the establishment of cells) under a structure commonly known as a protected cell company, segregated account company or segregated portfolio company (cell company). [3] A cell company, generally within a captive insurance context, may establish multiple accounts, or cells, each of which has its own name and is identified with a specific participant, but generally is not treated under local law as a legal entity distinct from the cell company.  The assets of each cell are statutorily protected from the creditors of any other cell and from the creditors of the cell company.

The proposed regulations provide that, for Federal tax purposes, a domestic series or cell, whether or not a juridical person for local law purposes, is treated as an entity formed under local law, and thus subject to individual entity Federal taxation.

With one exception, the proposed regulations do not apply to series or cells organized or established under the laws of a foreign jurisdiction.  The one exception to the exception is that the proposed regulations apply to a foreign series that engages in an insurance business.  This provision would incorporate many offshore segregated cell captive insurance arrangements as separate entities for Federal tax purposes.

Under the proposed regulations, classification of a series or cell that is treated as a separate entity for Federal tax purposes generally is determined under the same rules that govern the classification of other types of separate entities.

The proposed regulations will affect domestic series LLCs; domestic cell companies; foreign series, or cells that conduct insurance businesses; and their owners.  The proposed regulations also provide examples illustrating the application of the rule.

Example 1—Domestic Series LLLC:  Series LLC is a series organization.  Series LLC has three members (1, 2, and 3). Series LLC establishes two series (A and B) pursuant to the LLC statute of state Y, a series statute within the meaning of the proposed section.   Members 1 and 2 are the owners of Series A, and Member 3 is the owner of Series B.

Series A and Series B are each treated as an entity formed under local law.  In this example, classification of Series A is a partnership and of Series B is a disregarded entity for Federal tax purposes.

Example 2—Foreign Insurance Cell:  Insurance CellCo is a series organization (within the meaning of the proposed section) organized under the laws of foreign Country X.  Insurance CellCo has established one cell, Cell A, pursuant to a Country X law that is a series statute qualifying under the proposed regulations.  More than half the business of Cell A during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. Thus, if the activities of Cell A were conducted by a domestic company, that company would qualify as an insurance company within the meaning of sections 816(a) and 831(c).

Under the proposed regulations Cell A is treated as an entity formed under local law.  Because Cell A is an insurance company, it is classified as a separate corporation for Federal tax purposes.

Tomorrow’s blogticle will continue our discussion on additional changes and hot topics in 2011.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] 75 FR 55699-01. September 14, 2010.  http://www.gpo.gov/fdsys/pkg/FR-2010-09-14/pdf/2010-22793.pdf.  Last Accessed 1/31/2011.

[2] Del. Code Ann. Tit. 6, section 18-215.

[3] Vt. Stat. Ann. tit. 8, chap.141, §§ 6031-6038.

Tags: Business, Foreign corporation, insurance, Internal Revenue Service, IRS, IRS tax forms, Limited Liability Company, LLC

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