Comments on Proposed Series LLCs Regulations

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Section of Taxation OFFICERS Chair Rudolph R. Ramelli New Orleans, LA Chair-Elect Michael Hirschfeld New York, NY Vice Chairs Administration Leslie E. Grodd Westport, CT Committee Operations Priscilla E. Ryan Chicago, IL Continuing Legal Education William H. Caudill Houston, TX Government Relations Eric Solomon Washington, DC Pro Bono and Outreach John P. Barrie New York, NY Publications Alice G. Abreu Philadelphia, PA Secretary Megan L. Brackney New York, NY Assistant Secretary Thomas D. Greenaway Boston, MA COUNCIL Section Delegates to the House of Delegates Richard M. Lipton Chicago, IL Susan P. Serota New York, NY Last Retiring Chair William M. Paul Washington, DC Members Michael A. Clark Chicago, IL Julian Kim Washington, DC Mary Ann Mancini Washington, DC Mary A. McNulty Dallas, TX Steven M. Rosenthal Washington, DC Pamela Baker Chicago, IL W. Curtis Elliott, Jr. Charlotte, NC Scott D. Michel Washington, DC Eric B. Sloan New York, NY Brian P. Trauman New York, NY Jody J. Brewster Washington, DC Julie Divola San Francisco, CA Fred F. Murray Washington, DC Charles Rettig Beverly Hills, CA Bahar Schippel Phoenix, AZ LIAISONS Board of Governors Allen C. Goolsby, III Richmond, VA Young Lawyers Division Travis Greaves Washington, DC Law Student Division Tuan Ngo Fremont, CA Mr. Steven T. Miller Acting Commissioner Internal Revenue Service 1111 Constitution Avenue, NW Washington, DC 20024 Re: Comments on Proposed Series LLCs Regulations Dear Acting Commissioner Miller: April 30, 2013 10th Floor 740 15th Street, N.W. Washington, DC 20005-1022 202-662-8670 FAX: 202-662-8682 E-mail: tax@americanbar.org Enclosed are comments on the proposed income tax regulations dealing with series entities. These comments represent the views of the American Bar Association Section of Taxation. They have not been approved by the Board of Governors or the House of Delegates of the American Bar Association, and should not be construed as representing the policy of the American Bar Association. Enclosure cc: Sincerely, Rudolph R. Ramelli Chair, Section of Taxation Mark J. Mazur, Assistant Secretary (Tax Policy), Department of the Treasury William J. Wilkins, Chief Counsel, Internal Revenue Service Lisa Zarlenga, Tax Legislative Counsel, Department of the Treasury Curtis G. Wilson, Associate Chief Counsel (Passthroughs and Special Industries), Internal Revenue Service Joy Spies, Senior Technical Reviewer (Passthroughs and Special Industries), Branch 1, Internal Revenue Service Craig Gerson, Attorney-Advisor, Office of Tax Policy, Department of the Treasury ACTING DIRECTOR Janet In Washington, DC

ABA SECTION OF TAXATION SURVEY OF THE STATES REGARDING THEIR INTENT TO CONFORM TO THE CLASSIFICATION OF SERIES LLCs FOR FEDERAL INCOME TAX PURPOSES JOINT TASK FORCE ON PROPOSED SERIES LLCs REGULATIONS These survey results and comments ( Comments ) are submitted on behalf of the American Bar Association Section of Taxation and have not been approved by the House of Delegates of Board of Governors of the American Bar Association. Accordingly, they should not be construed as representing the position of the American Bar Association. Principal responsibility for preparing these Comments was exercised by Bruce P. Ely, James E. Long, Jr., J. and Leigh Griffith, in a joint effort by the Committee on State and Local Taxation and the Partnerships and LLCs Committee of the Section of Taxation. Substantive contributions and assistance in soliciting state participation were made by the following members of the Section s Committees on Partnerships and LLCs and State and Local Taxes: Edward Bernert, David J. Clark, Tim Van Valen, Richard Tomeo, Steve Frost, Bruce Johnson, John W. Simpson, and James W. Dawson, Jr. These Comments were reviewed by Paul Carman, Chair of the LLCs and LLPs Subcommittee of the Partnerships and LLCs Committee and William B. Prugh, Chair of the Committee on State and Local Taxation. These comments were further reviewed by Stewart M. Weintraub, of the Section s Committee on Government Submissions, by Michael A. Clark, Council Director for the State and Local Tax Committee and by Eric B. Sloan, Council Director for the Partnerships and LLCs Committee. Although the members of the Section of Taxation who participated in preparing these Comments may have clients that might be affected by the Federal or state tax consequences addressed by these Comments, no such member or the firm or organization to which such member belongs has been engaged by a client to make a government submission with respect to, or otherwise to influence the development or outcome of, the specific subject matter of these Comments. Contact Person: James E. Long, Jr. Telephone: (205) 521-8626 Fax: (205) 488-6626 E-mail: jelong@babc.com Date: April 30, 2013

EXECUTIVE SUMMARY On September 14, 2010, the U.S. Department of Treasury and the Internal Revenue Service issued proposed income tax regulations dealing with series entities such as series limited liability companies (Series LLCs), series business or statutory trusts, and segregated portfolio companies (herein called the Proposed Series LLC Regulations ). 1 Generally, the Proposed Series LLC Regulations classify each series within a Series LLC as a separate entity, which can then make the same tax elections as a regular LLC itself, e.g., to be classified as a partnership (if it has more than one member), to be disregarded (if it has only one member), or to be taxed as a C or S corporation. Under these Proposed Series LLC Regulations, the Series LLC itself (as opposed to the series within the Series LLC) is considered a separate tax reporting unit independent of the various series within it, but is not required to file a Federal income tax return (partnership return) unless it has its own income, deductions or credits (independent of that of the series within it) in any given taxable year. The Proposed Series LLC Regulations govern only Federal income tax issues; they expressly reserve a determination as to the Federal (and state) employment tax issues. The Proposed Series LLC Regulations request comments from interested parties, and the IRS has specifically requested comments from the American Bar Association Section of Taxation. To that end, a joint task force was formed at the request of the Chair of the Section ( Task Force ), and this questionnaire to the states is part of the Task Force s effort to inform the IRS as to whether or to what extent the states plan to conform with its proposed tax classification of series within a Series LLC and also to educate our members and taxpayers generally. Surveys were sent to the relevant departments or agencies for all fifty states, the District of Columbia and Puerto Rico. Responses were received from the relevant departments or agencies of 31 states. Some of the responding state departments or agencies did not respond to all of the questions asked. 1. State Employment Taxes. The IRS and the Treasury Department specifically requested comments on [h]ow series and series organizations will be treated for state employment tax purposes and other state employment-related purposes and how that treatment should affect the Federal employment tax treatment of series and series organizations (comments from the states would be particularly helpful). Nine (9) states (Alabama, Florida, Kentucky, Massachusetts, Missouri, Nebraska, North Dakota, South Dakota and Wisconsin) indicated that they would treat each series as a separate employer for state employment taxes, while five (5) states (Iowa, Minnesota, New Jersey, Nevada and Oregon) would not treat each series separately. The remaining states were either undecided or we have not received a response from their department or agency responsible for state employment taxes. 1 Fed. Reg. Vol. 75, No. 177 p. 55699 (Sept. 14, 2010). 2

2. Other State Taxes. Although the IRS s and Treasury Department s request for comments was limited to employment taxes, the Task Force determined that seeking input from the states regarding the classification of Series LLCs for other state tax purposes (especially income/net worth and transactional taxes) would be beneficial to taxpayers, tax administrators and practitioners. Twenty-two (22) states have responded so far that they would follow the Proposed Series LLC Regulations by classifying each series as a separate entity for income tax purposes that can make its own tax election. Of the 31 states responding to the survey, 2 no state has indicated that it would not follow the Federal rules, although six (6) states were undecided (Alabama, Hawaii, Indiana, Maryland, Minnesota and Ohio). Texas (although not responding to the survey) has ruled that for purposes of its margin tax, Texas will not follow the Proposed Series LLC Regulations but will treat all series as one taxpayer. With respect to sales and use taxes, the states were more undecided regarding whether to follow the Proposed Series LLC Regulations thirteen (13) of twenty-eight (28) states have indicated that they would follow the Federal rules for purposes of their sales and use taxes; ten (10) states were undecided; two (2) states responded that they would not follow the federal rules for purposes of sales and use taxes; three (3) states responded not applicable; and Texas s response suggests that it would not follow the Federal rules based on its single entity position. Tennessee responded that it would exempt from sales and use taxation any transfers of tangible personal property between and among the series because, for state law purposes, there is no change of title or ownership. In a supplemental response, Virginia indicated they would also consider the Series LLC one entity for sales and use tax purposes, and thus transfers between or among the series would not be subject to tax. STATE SURVEY RESPONSES We have received responses from thirty-one (31) states so far, although a few of the responses were only partially complete. 3 This was likely due to the broad scope of the survey and the fact that different state agencies or divisions within an agency are responsible for administering the various taxes below. For example, several states unemployment taxes are administered by the Department of Industrial Relations or Department of Labor, and not the Department of Revenue or Finance (collectively, the DOR ) which, as mentioned above, was the initial recipient of our survey. Our followup to the specific departments administering the unemployment taxes produced mixed results. 2 North Dakota did not respond to this question; South Dakota and Nevada both checked Not Applicable. 3 We have received responses (albeit partial in some cases) from the following states: Alabama, Alaska, Arkansas, California, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Missouri, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oregon, Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wisconsin. We have also inferred responses to certain questions in the survey from Texas based on published guidance issued by the Comptroller s Office. 3

As of the date of these Comments, nine states plus Puerto Rico and the District of Columbia have enacted legislation permitting the creation of Series LLCs with the internal liability shields for each series within the Series LLC. 4 Three (3) states reference series in their LLC statutes and permit their creation, but do not appear to provide the internal liability shields. 5 Of the known twelve (12) states that have enacted Series LLC legislation, ten (10) states have either responded or published guidance on their intent to conform to the Proposed Series LLC Regulations (Delaware and Oklahoma did not respond to the survey). The Kansas Department of Revenue s response (the Kansas Series LLC statute was passed in 2012 and was effective mid-year) was in the form of a letter saying they anticipated following the Proposed Series LLC Regulations but referred the Task Force to the Kansas Department of Labor for the employment and unemployment issues. The responses to the survey from the 31 states received to date are summarized below; however, please note that not every state DOR responded to each question and thus some of the rows will not add up to 31 responses. Please refer to the attached table for the state DORs specific responses to the survey. In some cases, we have supplemented the state s response if their DOR has issued a ruling or other public guidance regarding the classification of Series LLCs, e.g., Texas. In addition, we have inserted a NA Not Applicable response in some cases based on either partial responses or the laws of a particular state. States that were undecided at the time of responding to the survey could select ND meaning No Decision or Not Decided. For convenience, we aggregated each form of series entities into the term Series LLC in the questions below. Questions Concerning Net Income Taxes: 1. Does your state levy a net income-based tax on the following: a. Business entities: 1) C corporations? 26 Y 2 N 1 NA 0 ND 4 These jurisdictions include Delaware, District of Columbia, Illinois, Iowa, Kansas, Nevada, Oklahoma, Puerto Rico, Tennessee, Texas and Utah. See 6 DEL. CODE 18-215; D.C. CODE 29-802.06; 805 ILL. COMP. STAT. 180/37-40; IOWA CODE ANN. 489.1201; Kan. Sub. Bill for HB 2007, Section 1 (2012); NEV. REV. STAT. 86.296.3; OKLA. STAT. TIT. 18, 2000-2060; P.R. LAWS ANN. TIT. 14, 3967 (General Corporations Act 2009); TENN. CODE ANN. 48-249-309; TEX. BUS. ORGS. CODE ANN. 101.601; and UTAH CODE ANN. 48-3-1201. 5 These three states are Minnesota, North Dakota and Wisconsin. The Minnesota LLC statute states: Class, when used with reference to membership interests, means a category of membership interests that differs in one or more rights or preferences from another category of membership interests of the limited liability company. MINN. STAT. 322B.03 (2008). The North Dakota LLC statute states: Series means a category of membership interests, within a class of membership interests, that has some of the same rights and preferences as other membership interests within the same class, but that differ in one or more rights and preferences from another category of membership interests within that class. N.D. CENT. CODE 10-32-02 (2008). The Wisconsin LLC statute states: An operating agreement may establish, or provide for the establishment of, designated series or classes of members, managers, or limited liability company interests that have separate or different preferences, limitations, rights, or duties, with respect to profits, losses, distributions, voting, property, or other incidents associated with the limited liability company. WIS. STAT. 183.0504 (2008). 4

2) S corporations? 6 Y 23 N 1 NA 1 ND 3) General partnerships? 3 Y 25 N 1 NA 0 ND 4) Limited partnerships? 4 Y 24 N 1 NA 0 ND 5) Limited liability partnerships? 4 Y 24 N 1 NA 0 ND 6) Business or statutory trusts? 18 Y 8 N 2 NA 1 ND 7) Segregated portfolio companies? 7 Y 6 N 5 NA 9 ND 8) Other? 6 2 Y 4 N 23 NA 0 ND b. Non-business entities: 1) Individuals? 23 Y 5 N 1 NA 0 ND 2) Trusts? 23 Y 5 N 1 NA 0 ND 3) Other? 7 3 Y 3 N 24 NA 0 ND c. If an income-based tax is not levied on any of the above, please skip to Question 10 below. 2. Does your state s income tax parallel the Internal Revenue Code, e.g., by using Federal taxable income as the starting point? 24 Y 2 N 2 NA 0 ND 3. Will your state conform with the Proposed Series LLC Regulations by classifying each series as a separate entity that can make its own tax elections? 22 Y 1 N 8 2 NA 6 ND 9 4. Does your state automatically classify a business entity based on its Federal income tax classification (i.e., C corporation, S corporation, partnership, disregarded)? 24 Y 4 N 2 NA 0 ND 5. If your state does not automatically classify a business entity based on its Federal income tax classification, does your state use the Federal tax classification as a default classification (i.e., if the business entity does not elect a different status with the state, the Federal status will control)? 1 Y 3 N 23 NA 0 ND 6. If your state does not use the Federal classification to either control the state classification or as a default classification, do you have a mechanism for an election of business classification for state tax purposes? 0 Y 3 N 24 NA 0 ND 6 Florida and Tennessee both responded Yes to this question and provided additional information that is set forth in the footnotes to the table of responses below. 7 Illinois and Kentucky both responded Yes for estates, and Tennessee responded Yes and provided additional information that is set forth in the footnotes to the table of responses below. 8 Although Texas has not responded to the questionnaire, it has indicated publicly that it will not, as it will treat all series as a single entity. See Texas Comptroller of Public Accounts, Franchise Tax Frequently Asked Questions, available at http://www.window.state.tx.us/taxinfo/franchise/faq_tax_ent.html. Texas levies a franchise tax (a quasi-income/receipts tax known as the margin tax ) on partnerships (unless all direct owners are natural persons), limited liability companies, limited liability partnerships, corporations, business trusts, professional associations, business associations, joint ventures, etc. See TEX. TAX CODE ANN. 171.002. 9 These states include Alabama, Hawaii, Indiana, Maryland, Minnesota, and Ohio. 5

7. If your state recognizes each series as a separate tax reporting unit, will you impose your income tax on non-resident owners of a series if they have no other contacts with your state other than owning an interest in or being associated with (in the words of the Proposed Series LLC Regulations) the specific series that does business or derives income from your state, if the series elects (in the manner appropriate) to be classified as: a. Partnership? 17 Y 2 N 2 NA 7 ND b. C corporation? 3 Y 16 N 2 NA 7 ND c. S corporation? 15 Y 3 N 2 NA 8 ND d. Disregarded? 15 Y 1 N 2 NA 10 ND e. Business or statutory trust? 14 Y 3 N 3 NA 8 ND f. Any other trust? 16 Y 3 N 2 NA 7 ND 8. If your state does not recognize each series as a separate tax reporting unit, will you impose your income tax on non-resident owners of (associated with) each series of a Series LLC, if any series does business or derives income from your state and is classified as follows: a. If the Series LLC is classified as a C corporation for your state tax purposes? 0 Y 2 N 19 NA 6 ND b. If the Series LLC is classified as an S corporation for your state tax purposes? 2 Y 0 N 19 NA 6 ND c. If the Series LLC is classified as a partnership for your state tax purposes? 2 Y 1 N 18 NA 6 ND 9. Do you impose a composite tax return or withholding obligation on partnerships and LLCs with non-resident partners/members? 22 Y 3 N 3 NA 0 ND a. If so, will you require each series to file a separate composite tax return or separate withholding return and remittance? 18 Y 0 N 4 NA 4 ND b. Will you apply your entity-level income tax apportionment rules at the: i. Level of each series of the Series LLC? 17 Y 0 N 3 NA 7 ND ii. Series LLC itself level? 8 Y 6 N 4 NA 8 ND A critical question in the income tax section is question #3 - every state DOR that responded affirmatively to the survey question indicated that they would follow the Proposed Series LLC Regulations by classifying each series as a separate entity that can make its own tax election. However, Alabama, Hawaii, Indiana, Maryland, Minnesota and Ohio were undecided. The Alabama DOR noted that while the Federal treatment may not necessarily control, it will be considered a significant factor. Texas is the sole outlier so far, indicating that for purposes of its margin tax, Texas will not follow the Federal treatment and will treat all series as one taxpayer. 10 This one taxpayer approach 10 See Texas Comptroller of Public Accounts, Franchise Tax Frequently Asked Questions, available at http://www.window.state.tx.us/taxinfo/franchise/faq_tax_ent.html ( A series LLC is treated as a single legal entity. It pays one filing fee and registers as one entity with the Texas Secretary of State. It files one franchise tax report as a single entity, not as a combined group, under its main Texas taxpayer identification 6

may present problems for the collection of taxes from one series when they are attributable to another, and may pose constitutional problems for Texas to collect tax from a series that is not actually doing business in Texas. 11 This could also frustrate the intent of the members of the various series with respect to the insulation of each separate series from the liabilities of another series. With the exception of Texas, the responses so far are consistent with the published guidance on the state tax classification of Series LLCs. Tennessee recently joined California, Florida, Massachusetts, New York, and Texas as states that have published guidance on the state tax treatment of series limited liability companies and Tennessee is only the second state with its own series LLC statute to issue such a ruling (Texas is the other). 12 Under the facts considered by the Tennessee DOR in Letter Ruling 11-42, the Tennessee series LLC ( SLLC ) was wholly-owned by a limited partnership ( LP ). Each series of the SLLC s was also wholly-owned by the LP, and each series was anticipated to own a separate piece of rental property. The question presented by the taxpayer was whether the SLLC could file one Tennessee franchise and excise tax return, including all the activities of the SLLC and each of the series LLCs. A major factor to the Tennessee DOR s consideration of this issue was the Proposed Series LLC Regulations, which concluded that each series is considered as a separate entity for purposes of determining tax classification. Thus, for Federal tax purposes, a series with one owner is treated either as a corporation or as disregarded to its owner, and a series with two or more owners is treated either as a corporation or as a partnership. Based on the Proposed Regulations, the Tennessee DOR concluded that each series would be treated as a separate entity for determining tax classification for Tennessee franchise and excise tax purposes. 13 However, Tennessee s franchise and excise tax law departs from Federal income tax law on the question of whether single member LLCs are disregarded for Tennessee franchise and excise tax purposes. To be number. If one of the series has nexus in Texas, the entire series LLC has nexus in Texas. ); see also Tex. Policy Ltr. Rul. No. 201005184L (May 5, 2010). 11 The assertion of margin tax liability against a series or its owners that do not conduct any business activities in Texas may violate the Due Process and Commerce Clauses of the U.S. Constitution. It is a fundamental requirement of both the Due Process and Commerce Clauses that there be some definite link, some minimum connection between a state and the person, property, or transaction it seeks to tax. Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 777 (1992) (quoting Miller Bros. v. Maryland, 347 U.S. 340, 344 345 (1954)). This so-called nexus requirement derives from the proposition that the exercise of a state s taxing power over a taxpayer or its activities is justified by the protection, opportunities and benefits the state confers upon the taxpayer or its activities. If the state lacks the definite link or minimum connection with the taxpayer or its activities, it has not given anything for which it can ask in return. Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444 (1940). 12 Tenn. Ltr. Rul. No. 11-42 (Sept. 6, 2011). 13 The Tennessee franchise tax is based on the modified net worth of a limited liability entity while the excise tax is an income tax on a limited liability entity. See TENN. CODE ANN. 67-4-2006(a)(1); 67-4- 2106(a). 7

disregarded in Tennessee, a series must be a single member LLC that is disregarded for Federal purposes and is wholly-owned by a corporation. Under the facts of the ruling, the single member of the series was a limited partnership and the series would, therefore, not be disregarded for Tennessee franchise and excise tax purposes despite being disregarded for Federal income tax purposes. Accordingly, the SLLC and each series were required to file separate Tennessee franchise and excise tax returns. Significantly, the result set forth in this ruling is limited to Tennessee s franchise and excise tax, because for all other taxes (sales and use tax, property tax, business tax), the classification of LLCs is determined based on Federal income tax law, 14 although as discussed below, the Tennessee DOR has expressed the position that a transfer of tangible personal property between or among the Series LLC (as a single entity) does not trigger a sales tax because the ownership remains in the same entity. Accordingly, under the facts of the ruling, the SLLC and each series would be disregarded for all other Tennessee taxes, unless the entity checked the box to be treated as a separate corporate taxpayer. Tennessee s ruling is consistent with rulings issued by taxing authorities in California, Florida, and Massachusetts in that each state follows Federal regulations and tests each series of the Series LLC separately for determining tax classification. The ruling is also a useful reminder to tax practitioners that whether a state follows the Federal classification of Series LLCs is only the first question to ask practitioners must also consider any additional state-specific statutory provisions that may override the Federal treatment. The state DORs were also fairly uniform in their responses to Questions #7 and #9. With few exceptions, 15 most of the state DORs indicated that they would attempt to impose their income taxes on non-resident owners of a Series LLC, even if the nonresident owners only contact with the state was their ownership of a membership interest in the Series LLC, provided that the Series LLC elected to be classified as a partnership, disregarded entity, trust, or S corporation. In furtherance of this goal, eighteen (18) of the twenty-two (22) states with composite return or nonresident withholding requirements stated that they will require each series to file a separate composite or withholding return for its nonresident owners (the other four (4) states were undecided). However, if the Series LLC elected to be taxed as a C corporation, most of the state DORs said they would not attempt to assess the nonresident owner of the Series LLC for their income tax (without any other contacts with the state). 14 See TENN. CODE ANN. 48-249-1003. Technically, TENN. CODE ANN. 48-249-1003 states: LLC shall be treated as a partnership or an association taxable as a corporation, as such classification is determined for Federal income tax purposes. It does not specifically address when entities are treated as disregarded for Federal income tax purposes. 15 Kentucky and Tennessee responded that they would not impose income tax on a non-resident owner of a series, although the Tennessee DOR qualified its response that it was based on the assumption that the series was filing returns and remitting the appropriate tax. 8

Questions Concerning State Employment/SUI Taxes: 10. The IRS specifically requested feedback on whether the states should or will treat each series of a Series LLC as a separate employer or employing unit for purposes of their employment/unemployment insurance taxes. Will your state likely treat each series as a separate employer? 9 Y 16 5 N 17 1 NA 12 ND 18 11. Are your state s employment tax rules tied to or otherwise based on the Federal definition of employer? 19 Y 6 N 1 NA 1 ND 12. Even if a single member LLC is disregarded for Federal income tax purposes, does your state currently treat the single member LLC as a separate employer (as the IRS does now) if it hires employees? 20 Y 5 N 1 NA 1 ND a. If your state does not treat a disregarded single member LLC as the employer of record, would your state treat the member/owner of the single-member LLC as the employer of record? 3 Y 1 N 21 NA 2 ND 13. Does your state currently give the member and the single member LLC the option, as under IRS Notice 99-6 (prior to the recent amendments to the IRS Check the Box Regulations), as to which will be the employer of record? 4 Y 18 N 2 NA 3 ND As mentioned above, the responses were somewhat limited in this section due to the fact that the state DOR often does not administer their SUI taxes. This could explain the high number of no decision responses to Question #10 as to whether each series would be treated as a separate employer. Nine (9) of the fourteen (14) DORs that have responded substantively to this question so far indicated that they would treat each series separately. The responses to Questions #11 and #12 were consistent with the state s adoption of the Federal rules for determining the employer twenty (20) states follow the Federal rules and thus treat a disregarded single member LLC as the employer of record, while five (5) states depart from the Federal rules and treat the sole member as the employer of record. Questions Concerning Gross Receipts or Net Worth Taxes: 14. Does your state levy a gross receipts-based or net worth-based tax on regular LLCs (including, for example, the Texas franchise/margin tax, the Michigan business tax or the Ohio CAT)? If not, please skip to Question 16 below. 6 Y 19 N 2 NA 2 ND 16 Alabama, Florida, Kentucky, Massachusetts, Missouri, Nebraska, North Dakota, South Dakota, and Wisconsin. 17 Iowa, Minnesota, Nevada, New Jersey and Oregon. 18 While the Georgia Department of Revenue answered that it was undecided, they did indicate that Georgia would likely follow the Federal treatment. 9

15. Does your state intend to conform to the Proposed Series LLC Regulations by classifying a series as a separate entity that can make its own tax elections with respect to gross receipts-based or net worth-based tax? 3 Y 1 N 19 22 NA 4 ND a. If so, will your state impose its gross receipts tax or net worth tax on each series of a Series LLC? 2 Y 0 N 23 NA 5 ND b. If so, will your state impose its gross receipts tax or net worth tax on the Series LLC itself, if the Series LLC itself has gross receipts or a net worth independent of each series? 3 Y 0 N 23 NA 4 ND c. If so, will the Series LLC itself be required to file a state tax return if a series associated with the Series LLC has gross receipts or a net worth but the Series LLC itself (independent of the series) does not? 1 Y 2 N 22 NA 4 ND North Carolina and Tennessee were the only responding states to answer yes to both Questions #14 and #15. Neither of these states indicated that they would require the Series LLC to file a net worth or gross receipts tax return if the Series LLC did not have any business activity within the state (other than being associated with a series that has nexus with the state). We have inferred Texas responses to these questions based on the published guidance discussed above. Questions on Sales/Use Taxes: 16. Does your state levy a traditional sales and use tax on tangible or mixed tangible/intangible personal property? If not, please skip to Question 19 below. 26 Y 2 N 1 NA 0 ND 17. For purposes of its sales and use tax, will your state conform to the Proposed Series LLC Regulations by classifying each series as a separate reporting unit that can make its own sales and use tax elections? 13 Y 2 N 5 NA 9 ND a. If so, will you treat transfers of taxable property between two series or between a series and the Series LLC itself as a potential taxable transaction, unless there is a generally applicable exemption, e.g., wholesale sale or occasional sale? 13 Y 2 N 4 NA 8 ND b. If so, will you treat the nexus-creating activities in your state of one series to be attributed to: i. Another series? 2 Y 6 N 7 NA 14 ND ii. The Series LLC itself? 5 Y 3 N 7 NA 14 ND 19 Although Texas has not responded to the questionnaire, it has indicated publicly that it will not, as it will treat all series as a single entity. See Texas Comptroller of Public Accounts, Franchise Tax Frequently Asked Questions, available at http://www.window.state.tx.us/taxinfo/franchise/faq_tax_ent.html. 10

c. If so, will you treat the nexus-creating activities in your state of the Series LLC itself (independent of activities of any of the series within the Series LLC) to be attributed to each series within the Series LLC? 3 Y 4 N 7 NA 15 ND 18. For purposes of its sales and use tax, if your state does not conform to the Proposed Series LLC Regulations and treats the Series LLC and each series therein as a single sales and use tax reporting entity, will you treat transfers of taxable property between two series or between a series and the Series LLC itself as a potential taxable transaction, unless there is a generally applicable exemption, e.g., wholesale sale or occasional sale? 1 Y 3 N 14 NA 10 ND Not surprisingly, there was more uncertainty with respect to conformity to the Federal classification rules for purposes of sales and use taxes. In response to Question #17, thirteen (13) of twenty-eight (28) state DORs responding have indicated that they would follow the Federal classification rules and treat each series as a separate reporting unit for sales and use tax purposes, although nine (9) state DORs said they were undecided. All of the states that indicated they would follow the Federal rules also indicated in response to Question #17(a) that they would subject any transactions between two series to tax, unless another exemption applied. Tennessee and Virginia both provided supplement responses to explain their negative responses to Question 17. The Tennessee DOR expressed that sales of tangible personal property among or between the series of a Series LLC would not be subject to sales tax because, under state law, there was no transfer of property as the Series LLC retains title and possession. 20 Tennessee s supplemental information provided a more sophisticated analysis than the mere check the box responses to the questionnaire. Virginia provided a supplemental response that stated: Virginia s treatment will be similar to that of Tennessee, i.e., transactions between or among series of a Series LLC would not be taxable, the same as transactions between divisions of a corporation. The survey respondents were even more divided with respect to attributional nexus, although more state DORs were willing to attribute the activities of a series to the Series LLC itself than to another series (five (5) versus two (2)). Kentucky and Nebraska were the only responding states so far to affirmatively indicate that they would decouple from the Federal classification for sales and use tax purposes and presumably treat the Series LLC as one taxpayer. With respect to question #18, Nebraska, Rhode Island and Tennessee have so far been the only three (3) states to respond substantively to this question. Rhode Island would subject the intercompany transfer to sales tax, while Nebraska, consistent with its view of the Series LLC as one taxpayer for sales and use tax purposes, would exempt the intercompany transaction from sales and use taxes. As described above, the Tennessee DOR determined that transfers 20 Letter dated May 3, 2011 from the Tennessee DOR to J. Leigh Griffith transmitting the completed questionnaire (on file with the authors). 11

between and among the series did not change state law title and ownership, and thus would not be subject to sales or use tax (which rationale would also be followed by Virginia). Although Texas did not respond to the questionnaire, given its view that the Series LLC and all of the series are taxable as a single entity, a sales tax should not apply to transfers between or among the series. Questions Concerning Rental/Lease Taxes: 19. Does your state levy a sales tax or separate rental tax on leases of tangible personal property ( TPP )? If not, please skip to the conclusion below. 24 Y 4 N 1 NA 0 ND 20. Will your state treat each series as a separate reporting entity for purposes of the TPP leasing tax as opposed to the Series LLC itself? 5 Y 1 N 4 NA 6 ND a. If so, will your state impose its sales or rental tax on leases of TPP between two series? 10 Y 1 N 6 NA 10 ND b. If so, will the answer differ if the lease is between the Series LLC itself and one of its series? 1 Y 10 N 6 NA 9 ND c. If so, will the TPP leasing actions of one series in your state be imputed to the other series of the Series LLC or to the Series LLC itself? 0 Y 8 N 7 NA 11 ND d. If so, will the TPP leasing actions of the Series LLC itself be imputed to each of the series of the Series LLC? 0 Y 8 N 7 NA 11 ND e. If not, will your state disregard rentals between or among the various series of the Series LLC? 2 Y 7 N 7 NA 10 ND f. If not, will your state disregard rentals between a series of the Series LLC and the Series LLC itself? 2 Y 7 N 7 NA 10 ND 21. If your state does not treat each series as a separate reporting entity for purposes of the TPP leasing tax, will the Series LLC be the reporting entity even if it has no activity in the state? 4 Y 0 N 15 NA 10 ND 21 22. If your state treats each series as a separate reporting entity for purposes of the TPP leasing tax, will the Series LLC itself be required to file a return if the Series LLC itself (independent of the series) does not have leasing activity in the state? 0 Y 9 N 8 NA 13 ND The trend of uncertainty continued in the final section of our survey, devoted to rental or lease transactions, which in some states may be subject to a separate tax regime, e.g., Alabama, 22 or simply a transaction that is statutorily defined as a sale and thus subject to sales and use taxes. As to whether the state DORs that impose a rental/lease 21 Alabama, California, Iowa, Kentucky, Maryland, Minnesota, Missouri, North Dakota, South Dakota, Virginia. 22 ALA. CODE 40-12-220 et seq. 12

tax would conform to the Federal classification rules, five (5) states were in favor of following the Federal rules, and one (1) state (Nebraska) would not follow the Federal rules. Ten (10) states indicated that they would subject leases of tangible personal property between the series to rental/lease tax. Only North Carolina, Nebraska and Tennessee indicated that they may exempt intercompany transactions, although North Carolina would only exempt leases between the Series LLC and one of its series (vs. between two of the series). With respect to attributional nexus, no state DOR so far has indicated that they would attribute the leasing activities of one series to another series or the Series LLC itself, although eleven (11) states were undecided. Finally, Indiana as well as Nebraska and Tennessee will require the Series LLC to be the reporting entity for lease/rental taxes, even if the Series LLC has no activity in the state (independent of the series). Although Texas did not respond to the questionnaire, given its view that the Series LLC and all of the series are taxable as a single entity, the Series LLC should be viewed as the reporting entity for lease/rental taxes and leases of tangible personal property between or among the series should not be subject to rental/lease tax. The state DORs responses to the questionnaire, along with any general comments or specific qualifications to their answers, are summarized in the attached table of responses. 13

Questions Concerning Income Taxes Question 1 AL AK AR CA FL GA HA ID IL IN IA KA KY ME MA MD MN MO NE NV NJ NC ND OH OR RI SD TN TX UT VA WI 1. Does your state levy a net-income based tax on: a. C corporations Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y NA Y Y N Y Y Y N Y Y Y Y b. S. Corporations N Y 2 N N ND 3 N N 4 Y N 5 N 6 N N Y Y Y N N 7 NA N N N N 8 N N N Y N N N c. General P ship N N N N N N N Y N N N N N Y Y N N NA N N N N N N N N N N N d. Limited P ship N N N N N N N Y N N N N N Y Y N N NA N N N N N N N Y N N N e. Limited Liability P ship f. Business / Statutory Trust g. Segregated Portfolio Co. N N N N N N N Y N N N N N Y Y N N NA N N N N N N N Y N N N Y N N Y Y Y Y NA Y Y N Y ND Y Y Y Y NA N Y N N Y Y N Y Y N Y ND N ND ND NA NA Y N N Y ND Y Y ND ND NA Y 9 ND N N ND Y N Y NA ND NA h. Other NA N NA Y 10 NA NA NA NA NA NA N NA NA NA NA NA NA NA NA NA N NA NA NA N Y 11 NA NA NA Non-Business entities: Y N Y N Y Y Y Y Y Y Y Y Y Y Y Y Y NA N 12 Y N Y Y Y N Y 13 Y Y Y 1 Survey participants were provided with four answer choices to each question: Y (Yes); N (No); NA (Not Applicable ); or ND (No Decision or Not Determined). If a state provided any additional commentary or clarification to their response, it is provided in the footnotes below. 2 S corporations are subject to Alaska income tax to same extent gain and income is subject to federal income tax. 3 Only for certain non-resident shareholders of S corporations. 4 Except built-in gains and excess net passive income. 5 Except for certain types of income such as net passive income, capital gains, and built-in capital gains. 6 Comment for Questions 1(b)-(e): For S corporations, partnerships and LLCs, income tax is imposed at the shareholder, partner or member level. 7 Comment for Question 1(b)-(e): Nebraska does not impose an income tax directly on an S corporation, general partnership, limited partnership, or limited liability partnership; rather Nebraska imposes an income tax on the shareholders, partners, or members share of income received from these flow-through entities. 8 Comment for Question 1(b)-(e): Ohio levies pass-through entity withholding taxes (paid on behalf of partners, members and shareholders), but does not levy an income tax on the entities themselves. 9 If the Segregated Portfolio Company is taxed as a corporation for federal income tax purposes, then the Segregated Portfolio Company will be taxed as a corporation for New Jersey Corporation Business Tax purposes. 10 S corporations under IRC 1374 & 1375. 11 The following entities are also subject to Tennessee's income-based excise tax: 1. Limited liability companies; 2. Professional limited liability companies; 3. Registered limited liability partnerships; 4. Professional limited liability partnerships; 5. Cooperatives; 6. Joint-stock associations; 7. Regulated investment companies; 8. Real estate investment trusts; 9. State-chartered or national banks; 10. State-chartered or federally chartered savings and loan associations. See Tenn. Code Ann. 67-4-2004(37). 12 New Jersey imposes a gross income tax on partners, S corporation shareholders, trusts and individuals. 13 Individuals are subject to Tennessee's Hall income tax which applies only to certain dividend and interest income. i

Questions Concerning Income Taxes Question 1 AL AK AR CA FL GA HA ID IL IN IA KA KY ME MA MD MN MO NE NV NJ NC ND OH OR RI SD TN TX UT VA WI a. Individuals b. Trusts Y N Y N Y Y Y Y Y Y Y Y Y Y Y Y Y NA N Y N Y Y Y N Y 14 Y Y Y c. Other NA N NA NA NA NA NA Y 15 NA NA Y 16 NA NA NA NA NA NA NA NA NA N NA NA NA N Y 17 NA NA NA 2. Does your state's income tax parallel the Internal Revenue Code? Y 18 Y N Y Y Y Y Y Y Y Y Y Y Y Y Y Y 19 NA Y 20 Y Y Y Y NA Y Y Y N 21 3. Will your state conform to Proposed Series LLC Regulations by classifying ND 22 Y Y Y 23 Y Y ND Y Y ND Y Y 24 Y Y Y ND ND Y Y NA Y 25 Y ND Y Y NA Y N 26 Y Y Y 14 Trusts are subject to Tennessee's Hall income tax which applies only to certain dividend and interest income. 15 Estates. 16 Estates. 17 The following entities are also subject to Tennessee's Hall income tax which applies only to certain dividend and interest income: 1. Estates; 2. Partnerships; 3. Limited liability companies; 4. Joint-stock companies; 5. Business trusts; and 6. Any form of organization receiving taxable dividend or interest income. See Tenn. Code Ann. 67-2-101(5). 18 Corporate income taxes only. 19 Nebraska s starting point for corporations, estates and trusts is federal taxable income. The starting point for partnerships and S corporations is ordinary business income and for individuals, federal adjusted gross income. 20 New Jersey Corporation Business Tax follows federal rules in that Line 28 of federal form 1120 is the starting point for entire net income, but then New Jersey applies its own rules and deductions to that income and generally disallows any special deductions that were permitted for federal purposes below line 28. However, the starting point for any non-corporate entities subject to New Jersey Gross Income Tax under N.J.S.A. 54A:1-1 et seq. is not federal AGI. 21 Federal adjusted gross income. 22 The issues involving Series LLCs are generally unsettled in Alabama. While the federal treatment of Series LLCs will not necessarily control the Alabama treatment, it will be a significant factor. 23 If the LLC has elected to be taxed as a corporation, it will follow California corporation filing guidelines and estimated tax requirements, and will be subject to the minimum franchise tax. See http://www.ftb.ca.gov/professionals/taxnews/2011/october/article_4.shtml 24 The Kansas Legislature recently passed, and the Governor has signed, Substitute for House Bill 2207. This bill enacts a new serial limited liability company law in Kansas. At present, the Department of Revenue is in the process or reviewing the new law to determine how it will affect Kansas. Our initial impression is that it will bring us into conformity with federal law and, by extension, the new federal regulation. 25 New Jersey is generally regarded as a separate entity state and our LLC statutes provide that we will follow the federal income tax determination. 26 Responses to survey based on Texas Franchise Tax FAQs, available at http://www.window.state.tx.us/taxinfo/franchise/faq_tax_ent.html#tax_ent1 ( A series LLC is treated as a single legal entity. It pays one filing fee and registers as one entity with the Texas Secretary of State. It files one franchise tax report as a single entity, not as a combined group, under its Texas taxpayer identification number."); see also Tex. Policy Ltr. Rul. No. 201005184L (May 5, 2010). The Texas Comptroller did not respond to the survey and any responses noted herein are based on the public guidance published by the Comptroller s Offer regarding Series LLCs. ii

Questions Concerning Income Taxes Question 1 AL AK AR CA FL GA HA ID IL IN IA KA KY ME MA MD MN MO NE NV NJ NC ND OH OR RI SD TN TX UT VA WI each series as a separate entity that can make its own tax elections? 4. Does your state automatically classify a business entity based on its federal income tax classification (i.e., C corporation, S corporation, partnership, disregarded)? 5. If your state does not automatically classify based on Y Y Y Y 27 N Y Y Y Y Y Y Y Y Y N Y Y Y NA Y 28 Y Y Y Y NA Y 29 N 30 Y Y 31 N NA NA NA N NA NA NA NA NA NA NA NA N NA NA NA NA NA NA NA NA NA NA N NA NA Y 27 A series LLC is a master LLC whose organizing document provides for separate sub-units (series), which operate as independent LLCs. Features include: (a) Each unit has its own owners (members) and may be managed separately from the master LLC and other units; (b) Each unit must maintain separate books and records; (c) As with a regularly-formed LLC, the owners (members) of each unit are not financially responsible for the unit's debts and obligations; (d) A unit may conduct part of the business of the master LLC, or may conduct a wholly different business; (e) Each unit has its own assets and liabilities. The members of each unit are treated under the laws of the state where the master LLC is formed as owning an interest in only that unit, and have no rights as members of one unit in the assets or income of any other unit; and (f) Each unit is liable only for its own debts and obligations. In general, creditors of one unit may only make claims against the assets of that unit. We take the position that if each unit has the features listed above under the laws of the state where the series LLC was formed, then each unit will be treated as a separate entity for filing and tax purposes. See http://www.ftb.ca.gov/professionals/taxnews/2011/october/article_4.shtml 28 Generally, New Jersey will follow the federal definition of an LLC. However, a separate S corporation election is required in order for the LLC to be treated as an S corporation. LLCs can be treated as various business entities as set forth in N.J.S.A. 42:2B-69(a), which states that: For all purposes of taxation under the laws of this State, a limited liability company formed under this act or qualified to do business in this state as a foreign limited liability company with two or more members shall be classified as a partnership unless classified otherwise for federal income tax purposes, in which case the limited liability company shall be classified in the same manner as it is classified for federal income tax purposes. Therefore, in order for your business to be treated as an LLC and an S Corporation, you must first change your federal registration to that of an S Corporation. Once the federal registration is completed, you will need to make a separate S election with New Jersey using Form CBT-2553, http://www.state.nj.us/treasury/revenue/sub-s.pdf. If you need to make a retroactive New Jersey S Election then you can download Form CBT-2553-R, http://www.nj.gov/treasury/revenue/forms/cbt2553-r.pdf. If the LLC was in existence prior to making the New Jersey S Election then you must file two separate returns for the LLC and the S Corporation that document the period that each entity was in existence during the taxable year. 29 This comment applies to questions 4-6. For Tennessee income-based excise tax purposes, a business entity is classified as a corporation, partnership or other type of business entity consistent with the way it is classified for federal income tax purposes. With the one exception of single member LLCs whose single member is a corporation, all business entities subject to Tennessee's income-based excise tax are considered separate entities that must file their own returns for excise tax purposes notwithstanding the fact that they may be disregarded for federal income tax purposes. See Tenn. Code Ann. 67-4-2007(d). 30 The determination of responsibility for Texas franchise tax is based on the legal formation of an entity. An entity's treatment for federal income tax purposes does not determine its responsibility for Texas franchise tax. Therefore, each taxable entity that is organized in Texas or doing business in Texas is subject to franchise tax, even if it is treated as a disregarded entity for federal income tax purposes. The entity is required to file a separate franchise tax report unless it is a member of a combined group. If the entity is a member of a combined group, the reporting entity may include the disregarded entity with the parent's information; in that event, both entities are presumed to have nexus. See Texas Comptroller of Public Accounts, Franchise Tax Frequently Asked Questions, available at http://www.window.state.tx.us/taxinfo/franchise/faq_tax_ent.html. 31 Virginia generally conforms to the federal income tax classification of entities for Virginia income tax purposes. iii